Economics

of Digital
Transformation
Editors
Saša Drezgić
Saša Žiković
Marko Tomljanović

Faculty of Economics
and Business
ECONOMICS OF DIGITAL TRANSFORMATION
Publisher
University of Rijeka, Faculty of Economics and Business
For the Publisher
Alen Host
Editors
Saša Drezgić
Saša Žiković
Marko Tomljanović
Reviewers of Edition
Srdjan Redzepagic
Zoran Grubišić
Uroš Pinterić
Reviewers of Papers
Igor Cvečić
Alen Host
Jelena Stanković
Branimir Skoko
Hrvoje Šimović
Primož Pevcin
Robert Uberman
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Proofreader
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First Edition (2019)
300 copies

ISBN (hard copy) 978-953-7813-45-1

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ECONOMICS
OF DIGITAL
TRANSFORMATION
Editors:
Saša Drezgić
Saša Žiković
Marko Tomljanović

Research monograph – First Edition

Faculty of Economics
Rijeka, 2019 and Business
INTERNATIONAL SCIENTIFIC CONFERENCE
„ECONOMICS OF DIGITAL TRANSFORMATION“
May 2- May 4, 2018 – Rijeka – Opatija – Republic of Croatia

Organizer:
University of Rijeka, Faculty of Economics and Business, Rijeka, Croatia

Partners:
Cleveland State University, Maxine Goodman Levin College of Urban Affairs,
Cleveland, USA
Ural Federal University, Graduate School of Economics and Management,
Ekaterinburg, Russia
University of Nice Sophia Antipolis, Nice, France
University of Coimbra, Faculty of Economics, Coimbra, Portugal
University of Belgrade, Faculty of Economics, Belgrade, Serbia
University of Sarajevo, School of Economics and Business, Sarajevo, Bosnia
and Herzegovina
University of Zagreb, Faculty of Organization and Informatics, Varaždin, Croatia
University of Antwerp, Faculty of Applied Economics (TEW), Antwerp, Belgium
University of National and World Economy (UNWE), Department of Finance,
Sofia, Bulgaria
University of Ljubljana, Faculty of Administration, Ljubljana, Slovenia

Programme Committee:
Saša Drezgić, University of Rijeka, Faculty of Economics and Business, Rijeka,
Croatia
Alen Host, University of Rijeka, Faculty of Economics and Business, Rijeka,
Croatia
Saša Žiković, University of Rijeka, Faculty of Economics and Business, Rijeka,
Croatia
Danijela Sokolić, University of Rijeka, Faculty of Economics and Business,
Rijeka, Croatia
Davor Vašiček, University of Rijeka, Faculty of Economics and Business,
Rijeka, Croatia
Ned W. Hill, John Glenn College of Public Affairs, Columbus, Ohio, USA
Wolfgang Karl Härdle, Humboldt-Universität zu Berlin, Institute for Statistics
und Econometrics School of Business and Economics, Berlin, Germany
Srdjan Redzepagic, University of Nice Sophia Antipolis, Nice, France
Iryina Lendel, Cleveland State University, Maxine Goodman Levin College of
Urban Affairs, Cleveland, USA
Antonio Portugal Duarte, University of Coimbra, Faculty of Economics,
Coimbra, Portugal
Zhanna Belyaeva, Ural Federal University, Graduate School of Economics
and Management, Ekaterinburg, Russia
Saša Ranđelović, University of Belgrade, Faculty of Economics, Belgrade,
Serbia
Kemal Kozarić, University of Sarajevo, School of Economics and Business,
Sarajevo, Bosnia and Herzegovina
Almir Peštek, University of Sarajevo, School of Economics and Business,
Sarajevo, Bosnia and Herzegovina
Nina Begičević Ređep, University of Zagreb, Faculty of Organization and
Informatics, Varaždin, Croatia
Silvia Trifonova, University of National and World Economy (UNWE),
Department of Finance, Sofia, Bulgaria
Josef Windsperger, University of Vienna, Faculty of Business, Economics and
Statistics, Vienna, Austria
David S. Hulse, University of Kentucky, Gatton College of Business and
Economics, Lexington, USA
Maja Klun, University of Ljubljana, Faculty of Administration, Ljubljana, Slovenia
Katarina Ott, Institute of Public Finance, Zagreb, Croatia
Tea Golja, Juraj Dobrila University of Pula, Faculty of Interdisciplinary, Italian
and Cultural Studies, Pula, Croatia
Shieh Chich-Jen (Charles), College of Quantitative Economic, Huaqiao
University, Xiamen, Fujian, China
Andrija Mihoci, Brandenburg University of Technology Economic Statistics
and Econometrics, Germany
Sunčica Vujić, University of Antwerp, Faculty of Applied Economics (TEW),
Antwerp, Belgium
 FOREWORD
Dear authors, reviewers and readers,
It is our great pleasure to present first research monograph on the topic of Eco-
nomics of digital transformation. The main goal of this research joint venture
was to provide scientific proof of dramatic changes to contemporary and future
economic reality caused by increasing digitalization processes. As far as we
are informed, there are only few such publications which attempt to question
impact of digital transformation on traditional economic systems and activities.
Our contributors covered wide field of research within regulation economics,
industry and European single market issues, entrepreneurship, local economic
development, organization and innovation issues, digital marketing and mone-
tary policy in the era of digital currencies.
The papers published in this monograph present best papers presented at the
first conference of the Faculty of Economics and Bussiness of University of Rijeka
organized on the topic of “Economics of digital transformation” from 2nd to 4th of
May, 2018 in Opatija, Croatia (www.edt-conference.com). During the three days
of the conference more than 50 researchers from European region contributed
with their presentations. We are particularly proud on the results of our doctoral
workshop where nine young researchers presented their research while five pa-
pers were published in the monograph. In this way we are building our future re-
search capacities and expose young researchers to rigorous scientific challenge.
In addition, we also did our best to inform distinguished scientific indexing da-
tabases about our research contribution in order to enable wide dissemination
of our research efforts and boost interest of both researchers and practition-
ares about this growing field of research. The best papers from the conference
were selected for three distinguished scientific journals. These are Proceedings
of Rijeka Faculty of Economics-Journal of Economics and Business, Public
Sector Economics and Central European Public Administration Review. The
information on papers published in these journals is given by the footnote of
the topic of the paper.
Finnally, we would like to express our gratitude to our stellar keynote speakers
Edward (Ned) Hill from John Glenn School of Urban Affairs, Ohio University,
Iryna Lendl from Maxine Levine Goodman School of Urban Affairs, Cleveland
State University and Eugenio Leanza, Head of Mandate Services of European
Investmen Bank, as well as our panelists Cristian Popa, former Vice President
of European Investment Bank and Boris Vujčić, Governer of the Croatian Na-
tional Bank. We are immensely grateful to our contributors, reviewers, mem-
bers of programme and organization board, partner universities and sponsors,
as well as our students that received many complements from our guests for
their knowledge, manners and hospitality.

Rijeka, December 2018

Editors
 
 TABLE OF CONTENTS

INTRODUCTION.............................................................................................13

PART 1: REGULATION ECONOMICS...........................................................15

CHAPTER 1:
Nada Bodiroga-Vukobrat, Adrijana Martinović
Disruption and the Law in the Digital World: Some Thoughts
on the CJEU Uber Spain Judgment...........................................................17
CHAPTER 2:
Dubravka Klasiček
What happens to your Gmail and Facebook account after you die?......... 37
CHAPTER 3:
Davorin Pichler, Dražen Tomić
Electronic signature in legal theory and practice – new regulation............57
CHAPTER 4:
Ana Pošćić, Sandra Laleta
Sharing Economy and Worker’s Protection................................................71

PART 2: INDUSTRY 4.0 AND BEYOND/ DIGITAL SINGLE MARKET

IN EUROPE/ SOCIAL AND LABOUR MARKET ISSUES IN DIGITAL
WORLD.......................................................................................................... 89
CHAPTER 5:
Sanja Marinkovic, Ilija Nikolic, Jovana Rakicevic
Selecting location for a new business unit in ICT industry........................ 91
CHAPTER 6:
Anđelko Lojpur, Ana Lalević Filipović
Reindustrialization as a basis of new development paradigm
in transition countries............................................................................... 113
CHAPTER 7:
Gábor Rekettye, Gábor Rekettye Jr.
The effects of the digital revolution on costs and prices.......................... 131
CHAPTER 8:
Nedeljko Štefanić, Heri Bezić, Mihael Gudlin
More than technological evolution: organizational
and business impact of Industry 4.0.........................................................147
CHAPTER 9:
Maja Jandrić, Saša Ranđelović
Adaptability of the workforce in Europe – changing skills
in the digital era........................................................................................161
PART 3: ENTERPRISES IN DIGITAL ERA – CURRENT STATE
AND CHALLENGES..................................................................................... 175
CHAPTER 10:
Aleksandra Zečević, Jelena Radović – Stojanović
The Use of Information and Communication Technologies in Enterprises
in the Region: Level Achieved and Further Development........................177
CHAPTER 11:
Dejan Miljenović
In Search for Company Sustainable Value...............................................195
CHAPTER 12:
Mirela Müller, Brigitte Landmayer
The link between entrepreneurial learning and the use of E-Visitors
in the function of sustainable tourism development (example of the
study of the peninsula of Čiovo)...............................................................213
CHAPTER 13:
Marino Golob, Snježana Babić
Entrepreneurs’ Readiness in Small and Medium-Sized Companies
to Face Challenges in Digital Business....................................................225

PART 4: DOCTORAL STUDENT WORKSHOP...........................................237

CHAPTER 14:
Neda Vitezić, Antonija Petrlić, Uwe Lebefromm
From analytic to predictive digital performance measurement -
- A new challenge for controlling...............................................................239
CHAPTER 15:
Nela Milošević, Marina Dobrota, Sladjana Barjaktarović Rakočević
Digital Economy in Europe: Evaluation of Countries’ Performances........253
CHAPTER 16:
Nikola Zornić, Aleksandar Marković, Milica Maričić
Applying system dynamics to model the world of cryptocurrency............273
CHAPTER 17:
Dalibor Greganić, Milan Deskar-Škrbić
Public R&D Expenditure Efficiency and Knowledge Creation
in CEE Region..........................................................................................287
CHAPTER 18:
Milica Jovanović, Jasmina Dlačić, Milan Okanović
How does the digitalization impact society’s sustainable development?
Measures and implications.......................................................................299
PART 5: CONTEMPORARY ISSUES OF LOCAL ECONOMIC
DEVELOPMENT...........................................................................................317
CHAPTER 19:
Damir Juričić
Smart city concept and alternative procurement models
as instruments for reduction taxpayers and authority agency
costs in public investment projects...........................................................319
CHAPTER 20:
Miloš Lončar
The Impact of Internet of Things (IoT) and Digital Transformation
on Smart Environments and Integrated Ecosystems...............................333

PART 6: ORGANIZATION: ISSUES AND CHALLENGES IN DIGITAL

AREA/DIGITAL PUBLIC ADMINISTRATION AND ACCOUNTING.............351
CHAPTER 21:
Draženka Gašpar, Mirela Mabić
Social Media: Towards open government................................................353
CHAPTER 22:
Ivana Maric, Maja Vidovic
Happy organization - myth or reality for Croatian organizations..............371
CHAPTER 23:
Davor Vašiček, Ana Marija Sikirić, Martina Dragija Kostić
Financial position and sustainability of associations in Croatia ...............383
CHAPTER 24:
Lidija Romic
Constructing financial statements and the framework of accounting.......399
CHAPTER 25:
Milos Milosavljevic, Nevenka Zarkic Joksimovic, Nemanja Milanovic
Blockchain accounting:
Trailblazers’ response to a changing paradigm........................................425

PART 7: INNOVATION ECONOMICS/ BIG DATA IN BUSINESS

AND ECONOMICS........................................................................................441
CHAPTER 26:
Srđan Marinković, Zenaida Šabotić, Dragić Banković
What determines an optimal moment of accession to the EU?
Evidence from later enlargements............................................................443
CHAPTER 27:
Mirjana Radonjić-Simić, Sebastian Richter, Dennis Pfisterer
Reference Model and Architecture
for the Post-Platform Economy................................................................465
 CHAPTER 28:
Pawel Dobrzanski
Innovation expenditures efficiency in Central and Eastern
European Countries.................................................................................485

PART 8: DIGITAL MARKETING...................................................................505

CHAPTER 29:
Jelena Šormaz, Marija Kuzmanović, Veljko Jeremić
Customer Preferences towards Digital Marketing Strategies...................507
CHAPTER 30:
Branislav Dudić, Martina Drahošová, Zdenka Dudić, Ján Smoleň
The Online Marketing Activities of Travel Agencies in Slovakia...............527
CHAPTER 31:
Nataša Bojković, Veljko Jeremić, Marijana Petrović, Slaven Tica
Preferences for Carsharing Service Attributes:
A Survey of University Students in Belgrade............................................541
CHAPTER 32:
Hetesi Erzsébet, Klára Kazár, Révész Balázs
The Role of Personal Relationship and Information Technology
in Business Markets.................................................................................559

PART 9: MONETARY POLICY IN ERA OF DIGITAL CURRENCIES..........577

CHAPTER 33:
Zdravko Šergo, Jasmina Gržinić
Asymmetric price transmission in Croatia within the
real estate market …................................................................................579
CHAPTER 34:
Sanja Gongeta
EU Benchmark Regulation after LIBOR manipulation …….....................605
CHAPTER 35:
Mile Bošnjak, Ivan Novak, Ante Krišto
Monetary and absorption approach to explain croatian
current account ........................................................................................621
CHAPTER 36:
Admir Čavalić, Saliha Čabro, Faruk Hadžić
Cryptocurrencies: A critical review of concepts and definitions................633
CHAPTER 37:
Jovan Zafiroski
The bail-in principle – responsible banks for a sound
financial system........................................................................................641
INTRODUCTION

Digital transformation as a synonym for new technologies which enable innova-

tion, new concepts and processes in all our traditional activities is not any more
matter of our distant future or our presence. It is already part of our past. The
rapid transformation processes which occurred particularly in the last decade,
already transformed our life in such a radical way that we cannot imagine our-
self withour use of modern technological gadgets or applications. While at the
conferences and workshops we discuss about industry 4.0 and its significance
for industry and quality of life, the concept of industry 5.0 is beginning with its
practical implementation.
Therefore, in our research monograph, we deal with past, present and future.
The most relevant contribution of our research is, by using our analytical skills,
to provide some argumentation, elaborations and explanation on impact of all
these processes on our well being. Thus, we try to cover wide field of eco-
nomic issues and their interconnectedness, because in digital world, there are
increasing and emerging relations that we have never anticipated and expected
before. This makes our world more complex, and thus, makes our research
endavours even more difficult.
In our monograph our researchers deal with regulation economics under new
business models enabled by digitalization of industry and services, industrial
developments under new circumstances, position of enterprises, changing role
of local economic development under the new development paradigm of smart
cities, organization issues in digital era, emergence of innovation economics,
developments in digital marketing and new challenges for monetary policy un-
der occurance of cryptocurrencies and blockchain technologies. Finnaly, we
also include research papers of doctoral students which should drive our world
to be even more digital in near future.
Threfore, we hope that this monograph will find not just researchers but also
practitionares and provide both some questions and answers which will help
them to confirm their beliefs, initiate new research and provide arguments for
discussions. Of course, we will keep providing new food for thoughts. Until our
new contribution next year, we wish you enjoyable reading.

13
 PART 1

REGULATION ECONOMICS
 CHAPTER 1

Disruption and the Law in the Digital World:

Some Thoughts on the CJEU Uber Spain Judgment

Nada Bodiroga-Vukobrat1, Adrijana Martinović2

ABSTRACT

Whether or not we can call Uber’s business model as disruptive innovation (admittedly,
according to the author of the disruptive innovation theory, we cannot), the fact remains
that it has shaken the traditional models of passenger transport industries around the
world. The law does not respond well, or, better said, it is not able to react fast enough to
innovations. Technological and business inventions represent a threat to legal certainty.
When an innovative business model, facilitated by the use of new technologies occurs,
it is usually associated with a whole array of legal issues and conundrums. The law will
try desperately to fit it into the existing moulds of legal regulation. The recent Uber Spain
judgment (EU:C:987:2017) by the Court of Justice of the European Union (CJEU) pro-
vides a perfect illustration for this.
According to the CJEU, Uber is a transport company. This paper will analyse the argu-
ments presented in the judgment to show how law is not able to deal with rapid techno-
logical and societal changes in today’s digital world. The implications of this judgment
are far reaching, not just for Uber’s operations in the EU and world-wide, but also for
other game changers in the digital economy.

Key words: EU law, transport services, information society services,

single market for services, collaborative economy

JEL classification: K000, K200

1. Introduction
Ever since the adoption of the Digital Single Market strategy in 2015, the EU
is devoted to maximizing the growth potential of the digital economy, while at
the same time developing a ‘fit for purpose’ regulatory environment for online
platforms and intermediaries (European Commission, 2015:11). Since then,

* This research is supported in part by the Croatian Science Foundation under the project “Flex-
icurity and New Forms of Employment (Challenges regarding Modernization of Croatian Labour
Law (UIP-2014-09-9377) and in part by the University of Rijeka project No. 13.08.1.2.03 “Social
security and market competition”.
1 Full Professor, Head of Department of European Public Law, University of Rijeka, Faculty of
Law, Hahlić 6, 51000 Rijeka, Croatia. Phone: +385 51 359 527. E-mail: nadab@pravri.hr.
2 Assistant Professor, Department of European Public Law, University of Rijeka, Faculty of Law,
Hahlić 6, 51000 Rijeka, Croatia. Phone: +385 51 359 527. E-mail: adrijana@pravri.hr.

17
a number of initiatives, studies and reports have attempted to identify key chal-
lenges for the development and operation of online platforms (European Com-
mission 2016a; European Commission, 2016b; Gawer, 2016). They all point
to the important growth potential of online platforms and other business mod-
els facilitated by new digital technologies and identify the current regulatory
fragmentation as the key obstacle to their development and materialisation of
their benefits. Online platforms in the digital economy are given the broadest
possible meaning, from online advertising and market places to platforms for
the collaborative economy (i.e. from eBay to Uber) (European Commission,
2016a:2). However, these are all soft policy instruments, and there is not a
single proposal to date aiming to create common rules for the operation of such
platforms, despite their obvious cross-border implications.
Meanwhile, these initiatives are at odds with the legal and judicial develop-
ments in the field, as evident from the recent judgment of the CJEU in case
Uber Spain, and similar cases appearing before the CJEU.

2. Innovation, Uber and law in the digital world

Technological innovations and innovative business models lie at the founda-
tions of the Digital Single Market. These innovations have certainly disrupted
the traditional business patterns, even when not all of them can be labelled ‘dis-
ruptive’. According to the disruption theory developed by Christensen in 1995,
disruption is a process, whereby a smaller company (‘entrant’), with fewer re-
sources, successfully challenges established incumbent businesses (Chris-
tensen, 1997). Incumbents tend to overlook entrants, as they are concentrated
on their trajectory towards the most profitable, high-end of the market. By fo-
cusing on segments overlooked by incumbents, entrants establish themselves
and eventually move upmarket, overtaking incumbents’ mainstream custom-
ers. Hence, disruption occurs precisely because entrant’s innovation either
went unnoticed or was considered unimportant by the incumbent business to
deserve a(ny) reaction. Disruptive innovation differs from the so-called ‘sustain-
ing innovation’: whereas the latter makes a good product better in the eyes of
incumbent’s existing customer, the first is initially considered inferior by most of
incumbent’s customers (Christensen et al., 2015).
Since it was created, disruption theory has gained a life of its own, mostly to
the discontent of its author (Christensen et al., 2015). In the digital world, col-
laborative platform businesses are disrupting the disruption theory. Although
Christensen claims that Uber’s business model, or at least some of its versions,
is not a disruptive innovation under the disruption theory (because it has not
originated in the new or low-end market, but has straight away build a position
in the mainstream market), others point to the need to ‘update’ the disruption
theory (Moazed and Johnson, 2016; Cramer and Krueger, 2016; Sandstrom et
al., 2014). Their main argument is that platform businesses are very different
from the standard, ‘linear’ businesses on which the theory was built: whereas

18
linear businesses concentrate only on the demand-side, platforms create a
network or a triangular relationship which includes both the demand and the
supply-side (Moazed and Johnson, 2016; Hatzopoulos and Roma, 2017). The
distinctiveness of a platform business model is an important parameter which
should direct the search for disruptive competitors in the digital world (Moazed
and Johnson, 2016). It would be hard to claim that Uber has sneaked into the
market for passenger transport, for example, overlooked by incumbent busi-
nesses. Quite the opposite: almost everywhere it started its operations, it im-
mediately caused fierce resistance from the traditional taxi industry.
There is no denying that Uber’s business venture is innovative. The key innova-
tion is not the application itself, but the fact that it has enabled reduction of the
transaction costs (Rogers, 2015). Technological innovation facilitated organisa-
tional innovation and, coupled with aggressive expansion and corporate ‘cul-
ture of misbehaviour’, has changed the traditional business landscape (Jordan,
2017; Laurell and Sandström, 2016). But is it legal? Some claim that Uber’s
business model is predicated on lawbreaking and international illegality – and it
is time to put an end to it (Edelman, 2017). Let us then, rephrase the question: is
law capable of dealing with innovation, or is innovation doomed to be outlawed
(at first)? There are no uniform, nor straightforward answers to these questions.
If we concentrate on Uber, it all depends on the legal environment it is oper-
ating in and the type of service it offers. The underlying business model is the
same, but there is no single Uber service, there are dozens, catered to specific
needs of targeted groups (e.g. from standard UberPOP, UberX, Uber Black,
over UberBOAT, UberLUX to Uber Freight, Uber Family or Uber English)3 and
depending on the quality of the driver, type of vehicle and geographical area.
Possibilities seem endless: the new Uber Health service is even abandoning
the ‘old’ smartphone app connection and turns to text messaging or phone calls
to help patients who need rides to and from their doctors.4 Uber Express Pool
service is now competing with city buses.5
In the United States, Uber and similar companies have been classified and
regulated as ‘transportation network companies’ (‘TNCs’). In California, for ex-
ample, which was one of the first federal states to adopt such regulations, TNC
is defined as
“[…] an organization […] that provides prearranged transportation ser-
vices for compensation using an online-enabled application or platform
to connect passengers with drivers using a personal vehicle.” (§5431.(c)
of the California Public Utilities Code (PUC))

3 For a non-exhaustive overview of Uber’s services see <https://ride.guru/content/re-

sources/rideshares-worldwide#UBER>. In some cities, Uber was testing its self-driving
vehicles (cars and trucks) on public roads (e.g. San Francisco, Phoenix, Toronto, Pitts-
burgh). However, the testing is currently paused after a fatal accident, see <https://www.the
guardian.com/technology/2018/mar/19/uber-self-driving-car-kills-woman-arizona-tempe>; <https://
www.cnbc.com/2018/03/19/uber-self-driving-car-fatality-halts-testing-in-all-cities-report-says.html>.
4 <http://money.cnn.com/2018/03/01/technology/uber-health/index.html>.
5 <https://www.theverge.com/2018/2/21/17020484/uber-express-pool-launch-cities>.

19
A ‘participating driver’ or ‘driver’ means any person who uses a vehicle (meet-
ing prescribed requirements) in connection with a transportation network com-
pany’s online-enabled application or platform to connect with passengers. One
of the requirements for a vehicle is that it is ‘not a taxicab’ (§5431.(b)(4) PUC).
So clearly, there is a distinction between taxi services and transportation servic-
es offered through Uber and similar companies.
This is an example how regulatory framework was adapted to respond to the
new business model. First there was innovation, but the law followed, and (ar-
guably) delivered. In the EU, the situation is different. Innovative model arrived
quickly from the United States, but the law largely disables innovation.

3. Uber’s business model in the EU legal environment

Not surprisingly, Uber’s business operations have been subject to numerous le-
gal challenges throughout EU Member States, from outright bans to temporary
injunctions. Several cases involving Uber have reached the CJEU by means of
preliminary reference procedure: Uber Spain (C-434/15, EU:C:2017:981), Uber
France (C-320/16, EU:C:2017:511), Uber Belgium (C-526/15, EU:C:2016:830),
Uber Black (Germany) (C-371/17, EU:C:2016:830). Uber Spain case so far is
the only one in which a judgment was rendered. The remaining cases are still
pending (Uber France and Uber Black (Germany)), while Uber Belgium case
was dismissed as manifestly inadmissible. They all basically test the limits of
national taxi licensing requirements in view of the EU internal market freedoms.
For a fuller understanding of the issues presented herein, these cases also
merit a comparative evaluation.
Before analysing the case law of the CJEU, it is important to note that, despite
lacking common EU rules on collaborative platforms, it is not a priori ruled out
that collaborative platforms can in certain cases be considered as providers
of the underlying service and subject to sector-specific regulations, including
business authorisations and licensing requirements (European Commission,
2016b:6). The level of control or influence that the collaborative platform ex-
erts over the provider of such services, in particular concerning the setting of
price, contractual terms and ownership of key assets, is extremely significant
for determining whether the platform should be considered as providing the
underlying service (European Commission, 2016b:6). Hatzopoulos and Roma
(2017:127) rightly criticise the newly introduced distinction between platforms
‘offering only e-services’ and platforms ‘offering (also) the underlying services’.
The Commission’s reasoning is, in principle, followed by the CJEU. Arguably,
the CJEU’s attitude is quite less ‘pro-sharing’.
The services which are under scrutiny of the CJEU are services offered in direct
competition with the traditional taxi services. Viewed from the driver – provider
side, what Uber actually provides or sells is more than a service that connects
them with clients in need of a ride, it is a specific package or a business model
(Adamski, 2018). However, existing national licencing requirements, virtually

20
unaltered or at least fundamentally unchallenged for decades, are not fit to
accommodate this new business model, enabled and enhanced by the use of
new technologies.
The main competitors to the traditional taxi industry are UberPOP, UberX and
Uber Black services. UberPOP is a budget option, connecting non-profession-
al drivers with passengers in need of a ride, whereas UberX and Uber Black
services both include licensed professional drivers, and differ concerning the
class of vehicles used. UberPOP has so far been either voluntarily suspended
by Uber or banned by authorities in many cities around Europe, for failing to
comply with the licensing regulations.6

3.1. Uber Belgium: A lucky escape

The first case to appear before the CJEU involving Uber was Uber Belgium.
Luckily for CJEU, it did not have to take a stance on it: the case was dismissed
by Order of 27 October 2016 as manifestly inadmissible, because of deficien-
cies in a preliminary reference made by the Belgian referring court. The CJEU
found that the reference contained contradictory explanations, and that the
question referred was hypothetical in nature, thus making it impossible for the
CJEU to consider it. As can be discerned from the Order, the referring Dutch
court was deciding in a matter of prohibitory injunction lodged by the Brussels
taxi radio company against Uber Belgium, aiming to determine that Uber Bel-
gium committed unfair commercial practices by connecting, through an app,
unlicensed drivers with passengers in need of a ride, and requesting immediate
termination of such practices.
The CJEU found that the concept of ‘taxi service’ in Belgian legislation, as
explained by the referring court, is not defined by the quality of the driver and
does not exclude private individuals. The authorisation in accordance with the
Belgian legislation is based on the assumption that the service is provided for
remuneration – but the preliminary reference is not based on that assumption.
Without additional elements which would enable the court to conclude that the
activity in question is effectively subject to authorisation, the question posed
by the national court was deemed just hypothetical. The description of the ser-
vice in the main procedure is contradictory and very brief. It is described as
“ridesharing” – activity usually described as using the same vehicle by many
persons on the same journey, with the goal of reducing road traffic and sharing
transport costs. However, from the preliminary reference read in its entirety,
the disputed service is described as having the form of journeys effectuated by

6 Most recently in Oslo, <http://fortune.com/2017/10/09/uber-uberpop-norway-oslo-pause-reg-

ulation/>; Helsinki, <https://www.theregister.co.uk/2017/07/07/uberpop_is_finnished_in_helsin-
ki_until_2018/>; Zurich, <https://www.swissinfo.ch/eng/private-transport_uberpop-service-can-
celled-in-zurich/43400534>; and even before that in Italy, <https://www.theguardian.com/
technology/2015/may/26/uber-pop-italy-order-discontinue-unfair-competition-taxi>; France <http://
uk.businessinsider.com/uber-suspends-uber-pop-in-france-2015-7>; Netherlands, <http://www.
dutchnews.nl/news/archives/2015/11/uber-drops-uberpop-taxi-service-in-the-netherlands/ >.

21
driver and the destination is fixed by a passenger. The CJEU considered the
question as too imprecise and declared the references as inadmissible. Argu-
ably, the ‘right’ case to take the stand and decide on Uber’s destiny in Europe
was yet to come.

3.2. Uber Spain: an intermediation service is a service

in the field of transport
Uber Spain case originated from the legal proceedings brought by a profession-
al taxi drivers’ association from Barcelona (Associatión Professional Elite Taxi,
hereinafter: ‘Elite Taxi’) against Uber Systems Spain (hereinafter ‘Uber Spain’),
a company governed by Spanish law. The judgment never mentions the brand
name of the disputed service, but only describes it as “the provision, by means
of smartphone application, of the paid service consisting of connecting drivers
using their own vehicle with persons who wish to make urban journeys, without
holding any administrative licence or authorisation” (para. 2 of the judgment).
This is basically UberPOP service, as rightly identified in the Advocate General
Szpunar’s opinion (para. 14 of the opinion). Elite Taxi claims that such activities
amount to unfair practices in breach of the Spanish competition legislation and
that they should be banned.
The referring Spanish court considered that the question whether prior author-
isation is required was crucial for determining whether a breach of competi-
tion occurred. To correctly answer that question, the Spanish court needed the
CJEU’s help, given that it involved a question of interpretation of EU law. Nei-
ther national court, nor CJEU doubt that the provision of service was at stake.
Some authors remain sceptical. Adamski (2018:347) claims that the freedom
to provide services is irrelevant from the perspective of Uber’s business mod-
el, because authorisation requirements represent a market entry impediment,
which means that the rules on the freedom of establishment should apply. The
referring Spanish court, however, was uncertain as to what type of service: a
transport service, or an information society service, or a combination of both?
The answer to that question draws important consequences for the outcome
of the case.Free provision of services is one of the cornerstones of the internal
market, meaning that any restriction is in principle prohibited (Article 56 of the
Treaty on the Functioning of the European Union; hereinafter: TFEU). Further
acts of secondary EU legislation may regulate specific issues in connection
with specific services and their provision, especially concerning possible re-
strictions and derogations to that freedom. Such pieces of legislation, pertinent
for this case, include the Services Directive 2006/123, Information Society Ser-
vices Directive 98/34 (repealed by Directive 2015/1535, but applicable ratione
temporis to this case), and E-commerce Directive 2000/31.
The Services Directive 2006/123 establishes general provisions facilitating the
exercise of the freedom of establishment for service providers and the free
movement of services, while maintaining a high quality of services, but it does
not apply to ‘services in the field of transport, […]’ (Article 2(2)(d)). As explained

22
in Recital 21 of Directive 2006/123, transport services include ‘urban transport,
taxis and ambulances as well as port services’. The Information Society Servic-
es Directive 98/34 basically lays down the rules for notifying the Commission
about any draft technical regulations or standards for products or services be-
fore they are adopted in national law, as such rules are liable to create unjustified
barriers to trade between Member States and should be evaluated in advance.
The objective of the E-commerce Directive 2000/31 is to liberalise the provision
of information society services and approximate national provisions on informa-
tion society services relating to the internal market, the establishment of service
providers, commercial communications, electronic contracts, the liability of in-
termediaries, codes of conduct, out-of-court dispute settlements, court actions
and cooperation between Member States (Article 1(2) of Directive 2000/31).
For the definition of ‘information society service’ that Directive refers to Article
1(2) of Directive 98/34, as amended by Directive 98/48.
Prior authorisations, or similar licensing requirements, are by their very nature
liable to constitute restrictions to the free provision of services. Consequently,
the proper categorisation of the service in question does matter, as it may or
may not lead to the applicability and/or justifiability of national licensing require-
ments. Transport services, however, fall under the EU’s competences in the
field of common transport policy (Article 58(1) TFEU; Articles 90 – 100 TFEU),
which is governed by the completely different regulatory objectives and path-
ways than the internal market rules.
Both the internal market and common transport policy fall under the shared
competence of the EU and Member States and rest on the principle of non-dis-
crimination. Transport policy completes the internal market by creating trans-
port networks and removing technical and administrative obstacles in the
transport system, as well as eliminating distortion of competition or barriers to
market access which can result from different national transport regulations.
Given their specificity, transport services are explicitly singled out from other
services (Article 58(1) TFEU) and governed under the rules adopted in the
field of transport policy. Where such common rules do not exist, as is the case
for non-public urban passenger transport (i.e. taxi transport), differing Member
States regulations continue to apply.
In other words, where there are no common EU rules regulating the conditions
under which certain transport services are to be provided, EU Member States
are free to regulate them, in accordance with the general rules of EU law.
Supported by this regulatory framework, the CJEU delivered its Grand Cham-
ber7 judgment on 20 December 2017. The judgement in the Uber Spain case is
remarkably short on substantive issues: only 15 relatively brief paragraphs on
2 pages of an 11-pages judgement (paras. 34 - 48). Its impact is probably more
important in what it does not say, than in what it actually does.

7 The case is assigned to the Grand Chamber (composed of 15 judges), inter alia, if the difficulty
or importance of the case or particular circumstances so require (Article 60(1) CJEU Rules of
Procedure).

23
According to the Court,
“[…] an intermediation service, such as that at issue in the main pro-
ceedings, the purpose of which is to connect, by means of a smartphone
application and for remuneration, non-professional drivers using their
own vehicle with persons who wish to make urban journeys, must be re-
garded as being inherently linked to a transport service and, accordingly,
must be classified as ‘a service in the field of transport’ within the mean-
ing of Article 58(1) TFEU” (para. 48 and operative part of the judgment).
So, the Court is precise enough to name the disputed service ‘an intermediation
service’, but nevertheless, a service which “has to be classified as a service in
the field of transport”. Can we attach any significance to this careful choice of
words? As lawyers, we know that each term or word counts. And indeed, taken
on its own, an intermediation service is a service, which could fall under the
general scheme for the free provision of services under Article 56 TFEU and the
Services Directive. However, an intermediation service which consists of con-
necting drivers with passengers, by means of a smartphone application meets
the criteria for classification as information society service, as admitted by the
CJEU in the Uber Spain judgment (para. 35).
An information society service, as defined in Article 1(2) of Directive 98/34 and
Article 2(a) of Directive 2000/31, is deemed to be ‘a service normally provided
for remuneration, at a distance, by electronic means and at the individual re-
quest of a recipient of services’. ‘At a distance’ means that the service is pro-
vided without the parties being simultaneously present; ‘by electronic means’
means that the service is sent initially and received at its destination by means
of electronic equipment for the processing (including digital compression) and
storage of data, and entirely transmitted, conveyed and received by wire, by
radio, by optical means or by other electromagnetic means; ‘at the individual
request of a recipient of services’ means that the service is provided through
the transmission of data on individual request (Article 1(2) of Directive 98/34,
as amended by Directive 98/48).
Examples of ‘information society services’ include advertising of a dental prac-
tice via an online internet site (Vanderborght, C-339/15), the provision of on-
line information services for which the service provider is remunerated, not by
the recipient, but by income generated by advertisements posted on a website
(such as newspaper portal) (Papasavvas, C‑291/13), the operation of an online
marketplace, such as eBay (L’Oréal, C‑324/09), or online booking of flights and
accommodation through independent service providers (Uber Spain, opinion of
AG Szpunar, para. 34).
So why was Uber’s service ultimately deemed as a service in the field of trans-
port? In all of the above examples, the material or ‘non-electronic’ component
of the service, e.g. delivery of purchased goods, represents merely a perfor-
mance of a contractual obligation and is economically independent from the
non-material or ‘electronic’ service (Ker-Optika, C-108/09; Uber Spain, opinion

24
of AG Szpunar, paras. 30-36). In contrast to that, in this case the service was
provided at a distance, at individual request and by electronic means, but the
Court held that it was not a self-standing service. It was deemed as “more than
an intermediation service” by electronic means (para. 37 of the judgment). In
its essence, it is an intermediation service, but it cannot be detached from the
transport activity. The Court’s reasoning is basically that the transport activity
defines the intermediation service and represents its main component. It goes
even further by stating that
“[…] the provider of that intermediation service simultaneously offers ur-
ban transport services, which it renders accessible, in particular, through
software tools such as the application at issue […]” (para. 38 of the
judgment, emphasis added).
So, offering of a certain service is equalised to making a certain service acces-
sible in any manner, and offering of urban transport unfolds simultaneously with
the provision of an intermediation service. Should the activity of service offering
be treated distinctly from the actual service provision? Clearly not (see Alpine
Investments, C-384/93, para. 22), but that leaves us with conclusion that Uber
is providing a transport service as if it was driving the car itself. Admittedly, this
is not the case (the nature of Uber’s relationship with the drivers is neither a
subject-matter of this case, nor pertinent for its resolution).
There is not a word in the judgment about the nature of intermediation services,
taken by themselves. What if we ‘strip’ the innovation part, facilitated by the
technological progress, from the service? Could it then be regarded as a mere
intermediation, whereby an intermediary or a broker connects the principal (the
principal in that case being a driver) with the client, in exchange for a certain
commission? Would it be relevant in that case, whether such service was pro-
vided electronically or through an online platform or a smartphone app or by
any other means? The ensuing transaction between the principal and the client
would be irrelevant for the relationship between the principal and the interme-
diary. But could the latter relationship escape being qualified as a transport
service and potentially benefit from the general rules on the free provision of
services?8 We can only hypothesise, from the specific choice of wording in the
judgment, that innovation has no bearing on the conclusion, whatsoever:
“[…] the provider of that intermediation service simultaneously offers
urban transport services, which it renders accessible, in particular,
through software tools such as the application at issue […]” (para. 38 of
the judgment, emphasis added).
Once again, in the eyes of the law, innovation is nothing but a ‘glitch’, a tempo-
rary anomaly in the system to be straightened out.
Surely, if a ‘mere’ intermediation, without the ‘electronic’ component was con-
sidered, the facts of the case would not have permitted any different conclusion:
8 There are no common rules on intermediation in general, but only in specific sectors, e.g. in the
insurance sector (Directive (EU) 2016/97) or consumer credits (Directive 2008/48/EC).

25
an intermediary could never dictate the rules for the provision of service by the
principal, as Uber does. But it is quite indicative that this possibility was never
thoroughly investigated (and if necessary, dismissed) in the judgment or AG’s
opinion. While admitting that taken separately, those services can be linked to
different directives or TFEU rules on freedom to provide services, the Court
only provides an either-or situation: either information society services or trans-
port services are involved. There is no denying that the service has a ‘non-ma-
terial’ component – it brings the cross-border element to the case. In dismissing
the intervening Polish Government’s argument that the case is a purely internal
matter over which the Court has no jurisdiction, the Court states
“[…] the service at issue in the main proceedings is provided through a
company that operates from another Member State, namely the King-
dom of the Netherlands.” (para. 31 of the judgment)
So, the service is undoubtedly provided by electronic means, but nonetheless,
it is ‘more than an intermediation service’ (para. 37 of the judgment). According
to the Court, the activity of transport dictates the nature of the overall service.
Indeed, it does, if viewed only from the passengers’ standpoint. Passengers
use the app to find reliable transport, and they care little about who is actually
providing it. But what about the drivers who partner with Uber? The Court finds
that there would be no drivers without Uber.
Two main arguments that support the Court’s conclusion basically boil down
to the following: (i) without Uber, there would be no transport service; and (ii)
Uber has a decisive influence over the conditions under which the service is
provided (para. 39 of the judgment). The first part of the first argument is prob-
ably the least convincing part of the judgment: the Court merely states, with-
out any explanation, that without the application, the drivers would not offer
transport services. For sure, these are non-professional drivers, as we know
from the facts of the case. Did all of those non-professional drivers decided,
out of the blue, to start driving when they discovered the application, or were
they maybe somehow already involved in the transport business? What if there
were professional drivers among them, trying out a new and more efficient
method of connecting with the passengers? And how will this argument stand
in the face of other services offered by Uber, which include professional driv-
ers?9 The second part of this argument is that persons who wish to make an
urban journey would not use the services provided by those drivers. There
is no further explanation here either, but it makes a bit more sense: without
the application, there would simply be no connection between the passen-
ger and that particular driver. In either case, both parts of the first argument
seem too tenuous and unsubstantiated.10

9 This will be further analysed in Uber Black (Germany) case here below.
10 How will this conclusion reflect on Airbnb and other similar online accommodation booking plat-
forms, for example? It could also be claimed that many hosts would never offer their property for
rent, nor would many guests book those properties, had it not been so easy to connect over the
platform. Is Airbnb offering accommodation services?

26
The second argument, that Uber has a decisive influence over the conditions
under which the service is provided, is plausible and offers a stronger footing
to claim that this is ‘more than an intermediation service’. A significant control is
exercised in connection with setting of fares, type and appearance of vehicles
used, the conduct of drivers. In addition, all payment transactions go through
Uber, whereby Uber keeps a certain amount of commission, before wiring the
driver his part. A mere intermediary could never determine the salient features
of a service provision in such a way. More importantly, no matter how much
Uber contests it, the decisive influence argument will also bear significant con-
sequences for the nature of relationship between Uber and the drivers, i.e.
whether they are truly independent contractors as Uber claims.
The conclusion is that Uber’s intermediation service (which consists of con-
necting, by means of a smartphone application and for remuneration, non-pro-
fessional drivers using their own vehicle with persons who wish to make urban
journeys) is an integral part of, and must be classified as, “service in the field of
transport”. The consequence is that, since there are currently no common EU
rules on non-public urban transport services, Member States are free to reg-
ulate conditions under which such service is provided. This implies that even
a complete ban would be possible, since such a service is excluded from the
scope of existing EU law.
So basically, an application service is a transport service. In other words, forget
about the potential of online platforms and benefits to the digital economy and
society, by facilitating “efficiency gains” and increasing “consumer choice, [and]
contributing to improved competitiveness of industry and enhancing consumer
welfare” (European Commission, 2016a:3). Unlike advertising or connecting
sellers and providers with potential customers in an online market place, when
an application is connecting drivers with passengers, it is a transport service.
Given this argument, it would be irrelevant for the outcome of the case if the
connecting service was between professional drivers and passengers. It is not
the quality of the driver which determines the nature of the service, but the fact
that it is inherently linked to the transport service.
This judgment cannot be criticised as to its outcome: it follows the law as it cur-
rently stands. But it is a typical example how law stifles innovation. Forget the
revolutionary model of connecting drivers and passengers in real time: unlike
the smartphone application, the law does not respond at the click of a button or
the touch of a fingertip. We have to fit such situations into the existing regulato-
ry moulds, even when they are clearly unfit to accommodate them. Especially
when an issue is hotly debated, as Uber’s operations throughout Europe are: it
is much easier to keep a status quo in EU law and throw the ball back into the
Member States’ yard.
To state that the smartphone application connecting drivers with passengers
‘has no self-standing economic value’ (Uber Spain, opinion of AG Szpunar,
para. 32) without the transport component is perhaps legally correct, in view

27
of the existing law. But then, it is also a fatal blow to innovative business mod-
els, where it is, or at least should be conceivable to become the world’s lead-
ing non-public urban transport company, without actually owning any car. And
what about the unfair competition argument, so forcefully brought forward by
taxi drivers around Europe? If you take the non-professional drivers out of the
equation, i.e. someone just looking to make some extra money on the side, and
partner only with licensed professional drivers, that argument is void. Actually,
most national taxi companies are by now catching up with the digital world and
learning what it means to be competitive in the digital market: they have also
started using smartphone applications with the same or similar algorithms as
Uber to connect more effectively with passengers in need of a ride. And where
is the innovation in that? The market is still as closed as it was.

3.3. Uber Black (Germany) and Uber France:

Testing the reach of Uber Spain judgment
Out of two remaining pending cases involving Uber, perhaps the Uber Black
(Germany) case will carry a bit more weight.
Uber Black (Germany) case originates in a law suit filed by a Berlin taxi driver
against Uber BV, a company with a registered seat in the Netherlands. The
taxi driver successfully sought an injunction order against Uber to cease the
provision of a service which involves placing orders for chauffeur-driven rent
vehicles, through a smartphone application, which connects that passenger
to the nearest available vehicle. Passenger transport by chauffeur-driven rent
vehicles in Germany is different from taxi services. By definition, transport with
rent vehicles (Mietwagen) means passenger transport whose purpose, des-
tination and course are determined by the hirer and which is different from
the taxi transport (§ 49(4) Personenbeförderungsgesetz (Passenger Trans-
port Act), hereinafter: PbefG). An important distinction is that taxi vehicles are
usually made available at pre-authorised stops and that rides can be ordered
directly by passengers from the taxi drivers. In contrast to that, rent vehicles
can only take orders that have first been received at the company’s headquar-
ters and transmitted to the driver. This condition is not satisfied, for example,
when the driver notifies the company’s headquarters about a ride request
he received while performing another trip, and following that notification, ob-
tains the company’s authorisation (BGH, I ZR 201/87). Even if the entrepre-
neur is a single driver – his headquarter is his home address. Rent vehicles
may not bear taxi signs and attributes. Driver has to return to the company’s
headquarters after the ride, unless before or during the ride he telephonical-
ly receives another request from the headquarters (§ 49(4) PbefG). In view
of the technological progress, the term ‘telephonically’ used in this provision
is to be understood as transmitted to the driver also by e-mail, text message or
by other means of mobile communication (BGH, I ZR 3/16, para. 20).

28
In the present case, Uber Black service enabled drivers of rent vehicles to re-
ceive ride requests directly over the server in the Netherlands, without involve-
ment of another person at the company’s headquarters.
The first-instance and appellate courts ruled this to be anti-competitive behav-
iour in breach of the German PbefG.
In the revision procedure, the German Bundesgerichtshof (BGH) submitted a
request for preliminary ruling on 19 June 2017 (BGH, I ZR 3/16). There is no
available information about the date of the hearing before the CJEU, however,
the circumstances of the case and the questions referred can be discerned from
the application (OJ C 318 from 25.09.2017) and the BGH’s decision to refer the
matter to the CJEU. The question concerns the interpretation of Article 58(1)
TFEU and Article 2(2)(d) of Directive 2006/123 (the Services Directive), which
both refer to the special position of transport services. More concretely, the
BGH is concerned whether a company which makes available the smartphone
application, through which users can order chauffeur-driven rent vehicles from
undertakings licenced for passenger transport with rent vehicles, supplies the
service in the field of transport itself. This concern arises out of the fact that
the services of that company are closely connected to the transport service,
because the company determines the rules on price, processing of payments,
conditions of carriage, as well as advertises the vehicles under its own brand
name designation and applies uniform promotional offers. So basically, the fac-
tual situation is similar to the Uber Spain case, but the important difference
is that the services used here involve licenced professional drivers and rent
vehicles. Taxi transport is in competition with the chauffer-driven rent vehicles
transport, but subject to different set of rules under the German PbefG. The
problem consists in the violation of the rule from the German PbefG, which re-
quires that the mandate for chauffeur-driven rent vehicle has to first arrive at the
headquarter of the undertaking licensed for passenger transport with rent vehi-
cles, before a vehicle can be dispatched. This is the so-called ‘Rückkehrgebot
für Mietwagen’ - the ‘return mandate’ for rent vehicles (§ 49(4)(2) PbefG). BGH
considers that the provision at issue represents a rule regulating the practice
of a profession, justified in view of the protection of taxi service, which is bound
by fixed tariffs and obligation to contract (Kontrahierungszwang). This condition
is not satisfied when, as in the present case, the driver who is in the closest
proximity to the passenger receives the order directly from the server located in
the Netherlands, even though the undertaking’s headquarters simultaneously
receives an e-mail confirmation of the ride by the company responsible for the
smartphone application.
For BGH, the transport companies offering chauffeur-driven rent vehicles are
clearly liable for the breach of the return mandate under the PbefG, and thus
for the breach of competition. In that sense, Uber is also liable for the breach of
competition rules as their partner, regardless whether Uber itself falls under the
PbefG. However, BGH is concerned that this requirement may be at odds with
the EU rules on the free provision of services, which would not be applicable if

29
the intermediation service by Uber, in its existing form, represents a service in
the field of transport. If Uber’s service is not deemed as a service in the field of
transport, the BGH wonders if that requirement is justified from the perspective
of safeguarding of public policy, on the basis of objective of maintaining the
competitiveness and proper functioning of taxi services.
Although there are factual differences in comparison to the Uber Spain case,
especially concerning the type of service offered, it is highly unlikely that the
outcome of this case will be any different. The ‘no-service-without-transport’ ap-
proach will likely be followed here. The CJEU will not have to reply or even con-
sider the second question, posed in the event that it is concluded that Uber’s
services may not be deemed as services in the field of transportation. There-
fore, this highly controversial issue is left to the Member States.
Uber France case, in which the opinion of Advocate General Szpunar was de-
livered on 4 July 2017, is very similar to the Uber Spain case. It also involves the
UberPop service, i.e. connection of non-professional drivers with passengers
through online application. However, the disputed question revolves around
the fact whether the French national legislation prescribing the terms for perfor-
mance of non-public urban passenger transport, i.e. taxi services, should have
been notified to the Commission before it was adopted, in accordance with
Directive 98/34 on information society services. Of course, this question will
only be relevant if the service in question can be considered as an information
society service within the meaning of that Directive. In line with the Uber Spain
judgment, it clearly would not be the case.

4. Conclusion
In the United States, Uber started operating in 2010 (along with Lyft and similar
companies), and the first municipal and state regulations were being adopted
since 2014 (e.g. in California, Colorado, etc.). A legal solution was to regulate
them as transportation network companies – TNCs. As a consequence, these
companies are not taxi companies, and the regulatory accent is placed on the
questions of insurance and liability of drivers and companies. By 2017, the
majority of US federal states had a state-level regulation concerning TNCs.11
By contrast in Europe, Uber started its operations in late 2011.12 In 2018, the
only solution we have for its innovative business model is to basically call it a
transport or taxi company. In this case, regulation has hindered innovation.
Would it be possible to apply a similar regulatory pattern in the EU? This would
require a clear and unequivocal political will to admit that there is a need for
common rules in this area. Such determination is obviously lacking, as it would
imply a significant overhaul of national regulations on non-public urban passen-
ger transport or taxi transport, an area which has traditionally been resilient to

11 See <https://policy.tti.tamu.edu/technology/tnc-legislation/>.
12 The first European Uber office was opened in Paris in December 2011.

30
change and Europeanisation. But it would also require from the Member States
to admit that the platform or application enabled service connecting passengers
with drivers (such as Uber’s service) is not, by its nature, a transport service. By
its nature, it still is, even under the current set of rules, an online intermediation
service – whether we consider it detachable or non-detachable from its material
component, the transport, is only the next step relevant for the decision how
to regulate the provision of the service in question. But to completely deny its
innovativeness is simply an untenable option.
The CJEU case law in Uber cases shows us that we are a long way from reg-
ulating online intermediation platforms “in a manner that truly serves compe-
tition, innovation and user choice” (Geradin, 2016). This paper should not be
understood as a plea for market liberalisation. Quite the opposite, rules on com-
petition, consumer protection, labour standards, liability, etc. are tremendously
important in the regulation of online platforms.
As much as it can hinder, regulation can also enable innovation. So, it is not
about liberalisation, but about recognising and adequately defining inno-
vative business models, and creating a specific set of rules or adapting the
existing ones to regulate their operation. The degree of control exercised by
the platform over the provision of the underlying service is a starting point
for determination of the service in question, but it is also the most elusive
one, since it can shift and vary. The sensitivity or protected status of a cer-
tain field or industry, in view of its public importance, is an additional factor
to take into account, but it should not serve as an excuse to refrain from any
action. Regulatory fragmentation is recognised as one of the most important
obstacles for the proper functioning of the digital single market. At this pace,
by the time the EU decides whether and how to build the common regulatory
approach, Uber and the likes may be long gone from the market, because
they are breaking laws in many Member States.

31
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35
 CHAPTER 2

What happens to your Gmail

and Facebook account after you die?

Dubravka Klasiček1

ABSTRACT

Many people have at least one e-mail account and/or profile on some type of social me-
dia, but they seldom think about what will happen to these after they die. In some cases,
what happens to an account or profile after its user dies, is determined by providers’
terms of service (ToS). However, sometimes these issues are defined elsewhere – in
help forums, help centers, Q&A forums; as is the case with Gmail (Gmail Help Forum or
Google Accounts Help Center) and Facebook (Facebook Help Center).
This paper will explore what happens to Facebook profiles and Gmail accounts after
their users die and in order to do so, it must explore the reasons behind it. Its second
part will deal with the fact that such important issues are usually not found in ToSA, but
elsewhere. Because of that, two conclusions arise: 1. since these policies are found in
various forums, a user will have a hard time being aware of their existence, unless he/
she knows where to look for them specifically and 2. as a result, a user will not be able
to consent to these policies, while consenting to ToSA.

Key words: Gmail, Facebook, digital asset, inheritance, contracts of adhesion

JEL classification: K12, K15, K24

1. Introduction
What happens to personal tangible items after their owner dies is clear under
inheritance law – they pass on to decedent’s testate or intestate heirs. Howev-
er, today, letters have been replaced by e-mails; photo albums by different sites
where they can be uploaded and shared with friends or public; diaries are today
replaced by blogs; bills are paid on-line; works of art are uploaded to various
sites. People’s lives have become digitized. The number of digital accounts of
an average person is growing on a daily basis. Most of us already have numer-
ous e-mail accounts, profiles on various social media sites, financial accounts
and on-line store accounts. Yet, what happens to all of those digital accounts
post mortem is, for most people, still an enigma.

1 Assistant Professor, Faculty of Law, University J. J. Strossmayer, S. Radića 13, 31000 Osijek,
Croatia. Scientific affiliation: civil law, inheritance law, law of obligations. Phone: +38531224500.
Email: dklasicek@gmail.com

37
Even if some have thought about what will happen to their online accounts and
made plans for digital inheritance, it is important to know that rules governing
digital accounts are not as straightforward as the rules that apply to inheritance
of tangible assets. Account holders are not as free to decide what will happen
to their online accounts post mortem as they are in deciding about their tangi-
ble items. Major obstacle to making plans for what will happen to one’s digital
account is found in internet service providers’ (ISP) rules either put in terms
of service agreements (ToSA) or elsewhere. To elaborate, most ISPs prohibit
account access to anyone other than the original account holder, including ac-
count holder’s heirs. Of course, it is possible to leave heirs log-in information
so they can access an account, but as soon as an ISP learns about account
holder’s demise, it will probably lock anyone out of the the account and might
even delete it.
Therefore, making plans for digital assets stored on ISPs’ servers and putting
them in a will might not work. As most commentators agree, the best solution
would be to negotiate directly with an ISP and resolve this issue on an individu-
al level. Today, exactly that is possible when it comes to two of the most popular
e-mail and social media providers – Google and Facebook.
The aim of this paper is to try to clarify to average Gmail and Facebook ac-
count holders what are their options concerning their accounts after they die
and why. Therefore, the first part of this paper will concentrate on what some
of the commentators that dealt with this topic had to say about influence of
ToSA on inheritability of digital accounts and testamentary freedom of account
holders. This part will also concentrate on existing law that govern ISPs and
their rules about non-transferability of digital accounts. Solutions to this prob-
lem presented by Gmail and Facebook will also be analyzed, as examples of
what might be done to aleviate problems account holders face today, while
planning for their digital inheritance. The last part of the paper will deal with
problems that stem from the fact that these solutions are not found in ToSA,
but in various help forums.

2. Literature and legislation review

2.1. Terms of service agreements
As Watkins (2014) explains, whenever somebody wants to open an account
with an ISP, they have to consent to a set of rules governing said account.
These rules are incorporated in ISPs’ ToSA and they dictate account holder’s
relationship with the provider. According to Ronderos (2017) ToSA are con-
tracts of adhesion and the reason they are made in this form is, among other
things, TO reduce ISPs’ administrative costs.
These types of contracts are also known in Croatian legal system. Klarić/Vedriš
(2014) define them as contracts concluded after one party accepts previously
determined and announced conditions of another party and are usually used

38
by parties that conclude a lot of completely identical (standardized) contracts
on a daily basis. Their conditions can usually not change – other party can only
accept or decline them. Banta (2014, p. 822) calls it ‘take it or leave it’ principle.
Watkins (2014) and Tarney (2016) explain that ToSA usually contain a lot of
clauses, some having to do with transferability of an account, possible deletion
after a certain period of inactivity and fate of an account after its holder dies.
However, as Cummings (2014) emphasizes, some providers do not have rules
on what is to happen to deceased’s account when he/she dies in their ToSA,
but rather, in their Q & A or help forums. So even if a diligent account holder
went through all of ToSA and read it, he/she would still not know that any spe-
cial rules concerning what happens to their account or profile after they die,
even exist. However, in Banta’s (2014) opinion, that does not matter since if an
account holder agreed to ToSA, it means he/she agreed to all ISP’s policies,
contained in ToSA or elsewhere.
Banta (2014) and Watkins (2014) also mention that ToSA usually contain claus-
es determining the law applicable to an account, which is extremely important
for anybody trying to devise his/her account upon death, since the devision of
digital assets might be possible under account holder’s country of origin’s law,
but it might not be possible under the law that is applicable to an ISP that con-
trols the account.
According to Banta (2014) and Ronderos (2017) there are two basic types of
ToSA: clickwrap agreements that require future account holder to click ‘I agree’
as a way of indicating his/her consent. These agreements are usually deemed
enforceable, because they reasonably communicate ToS to future account
holders. On the other hand, browsewrap agreements, which are displayed to
future account holders, but do not require them to click ‘I agree’, might not be
enforceable if future account holder did not have actual or constructive knowl-
edge of the terms or conditions.
Sherry (2012, p. 205) and Varnado (2014, p. 747) remark that it is interesting
that maybe two people in one thousand actually read ToSA and most of those
who read them, read only certain parts. Eichler (2016) and Ronderos (2017)
agree and mention an important reason why future account holders probably
do not read ToSA – they are usually very long and their provisions are ambigu-
ous to an average person. However, as McCarthy (2015) emphasizes, regard-
less of that, ToSA are binding contracts between an account holder and the
provider and they define access to files on digital accounts. The same author
mentions one important issue: even if an account holder read ToSA, ISPs could
change them without any notice, which would create additional problems con-
cerning what happens to decedent’s digital assets, because it is possible for
an account holder to believe his/her account and its content is devisable, but
ISP has changed ToSA and made it undevisable. Banta (2014) and Eichler
(2016) agree that ToSA are usually not very clear and are extremely long so
most account holders do not read them, but just click “I agree” on the bottom.

39
Banta (2014) also adds another reason for that: account holders have no real
alternative to ToSA, because ToSA are offered in ‘take it or leave it’ fashion, so
if an account holder did not like some of the rules, he/she would not be able to
negotiate and change them.
As a result of account holders not reading ToSA, most of them are not aware
of any rules governing their account, especially the ones determining whether
transfer of digital assets upon death is allowed. And even if some account hold-
ers were aware, the market usually does not provide any choice between ISPs,
since most of them have similar rules concerning devisability of digital assets.
Darrow/Ferrera (2007) and Banta (2014) all agree ISPs are always the stronger
party, able to solely shape ToSA and up until now nobody has tried to protect an
account holder as a weaker party. Banta (2014) deliberates that this might be
because digital assets are intangible and stored on ISP’s servers, so people do
not view them the same way as they do their tangible assets.
When it comes to one-sided changes of ToSA, it has to be pointed out that there
are some ISPs that inform their account holders about changes to ToSA. Face-
book, for example in their ToSA under ‘Amendments’ states: “We’ll notify you
before we make changes to these terms and give you the opportunity to review
and comment on the revised terms before continuing to use our Services. ...
Your continued use of the Facebook Services, following notice of the changes
to our terms, policies or guidelines, constitutes your acceptance of our amend-
ed terms, policies or guidelines.”2
Most ToSA are similar concerning transferability of an account post mortem.
However, it has to be indicated that not all of them have exactly identical rules.
Therefore, Banta (2014, p. 817) lists four possible solutions to what happens
to digital assets after the death of an account holder: (1) these assets can be
expressly prohibited to be transferred upon death or in general (inter vivos and
mortis causa.); (2) ToSA can generally prohibit transferability, but might allow it
with the permission of ISP; (3) transferability of digital assets might be explic-
itly allowed according to ToSA and (4) ToSA might be silent about account’s
transferability upon death of its holder. It would seem that the majority of these
agreements either prohibit transfer or are silent about it. Some ToSA will even
give ISP the power to, not only forbid transferability of an account, but terminate
an account at any time for any reason. Watkins (2014) agrees and lists what
different ToSA might state concerning account transferability a little differently
than Banta, but the point is still the same: (1) ToSA might determine whether
the account can be transferred (inter vivos or mortis causa); (2) if it is to be de-
leted after a certain period of inactivity or (3) if something else (if anything) is to
happen to it after its holder dies.
What will happen to an account and its contents also greatly depends on what
rights an account holder has over account content. As Cahn (2014) and Eichler
(2016) state, ToSA may determine that an account holder owns digital content,

2 https://www.facebook.com/terms.php (last visited on March 30, 2018).

40
so it can be sold, donated or devised upon death; or he/she simply purchases
a license, which expires upon death.
Regardless of what rights account holder has, Banta (2014) and Truong (2009)
point out that, when it comes to digital assets, most of them have one thing
in common – their inheritability is controlled by ToSA between an ISP and a
person who uses their services or purchases digital product. Concerning this
conclusion, an interesting point is made also by Banta (2014) when she ex-
plains that, there were always contracts that a person could make, which limit-
ed his/her freedom of testation. However, these contracts were always aimed
at transfer of property to certain persons according to the will of their owner
(in Croatia one example is the contract on lifelong maintenance, Law of Ob-
ligation, Art. 579). ToSA, however, have a completely opposite effect – they
limit freedom of testation, but, at the same time, prohibit any transfer of assets
stored in the digital account. So, ISPs will not let heirs access the account and
its content, but they will rather destroy it or keep it on their server indefinitely.
As the same author (2017) emphasizes, it is inconceivable that ISPs consid-
er ownership interests of an account holder over the content of his/her ac-
count to cease at death, which is completely in opposition to basic principles of
succession law (Banta, 2017)
Accordingly, since most ToSA prohibit descendability and devisability of digital
assets, Banta (2014) states on several places in her paper that ToSA severely
violate principles of succession law because these agreements preclude tes-
tate or intestate heirs from inheriting deceased’s accounts. They might be valid
under the principles of contract law, but it is unacceptable how they violate
principles of succession law. Banta (2014) and Truong (2009) agree that ToSA
should even be void because they are against public policy by reason of them
letting ISPs determine what ownership interests an account holder has in his/
her digital assets during life and, also, what will happen to them after he/she
dies. Simply put, ToSA are ignoring account holder’s ownership and testamen-
tary intent. Banta fears that by allowing contracts drafted by just one party to
determine what will happen to our digital assets, a dangerous precedent might
be set – we might open the door to the same thing happening to our tangible
assets or any new type of property that might be developed in the future.
As can be concluded, Banta, in most of her papers about digital inheritance
(2014, 2016, and 2017), writes about this negative impact of ToSA. The same
is found in the paper written by Darrow/Ferrera (2007, p. 314), who state that
boilerplate provisions in contracts of adhesion (ToSA), drafted solely by ISPs,
should not be allowed to rewrite probate law in a way that prevents heirs to
inherit what would otherwise be inheritable. Ronderos (2017) also stresses that
ISPs’ ToSA prevent the inheritability of digital assets, so they have now become
the main authority in governing the transfer of digital assets at death.
Most commentators agree with these statements, as was shown in this part.

41
2.2. Stored Communications Act (SCA)
The law most important for U.S. based ISPs’ reluctance to let anyone access de-
cedent’s accounts or profiles is Electronic Communications Privacy Act (ECPA,
1986), primarily Title II, commonly known as Stored Communications Act (SCA,
1986). Borden (2014) notes that SCA was prompted by U.S.’s Congress’ desire
to control the federal government’s interception of electronic communications
while conducting criminal investigations. At the beginning, Congress adopted
Omnibus Crime Control and Safe Streets Act of 1968, which was commonly
known as Wiretap Act. This act made it illegal to “intentionally intercepts, en-
deavors to intercept, or procures any other person to intercept or endeavor to
intercept, any wire, oral, or electronic communication“, (§ 2511 (a)).
According to Borden (2014) primary focus was to prevent government officials
from intercepting electronic communications from individuals, unless one of the
exceptions listed in the Act did not exist. With the development of technology,
electronic communication expanded to include various ways of communicating
that did not exist earlier, so Congress had to update Wiretap Act by enact-
ing before mentioned ECPA (1986), which in its Title II (SCA) deals with com-
puter communications. SCA, in its chapter 2702, prohibits electronic service
providers and remote computing services from disclosing account content to
unauthorized individuals. Cahn (2014, p. 1708) lists the types of ISPs as: ESC
providers – those that provide communications service; RCS providers – those
that provides storage service and ISPs that perform both of these functions at
the same time. Regardless of the type of ISP in question, if they are available
to public, they fall within the scope of SCA.
Cahn (2014, p. 1700-1) also explains that SCA regulates relationship between
government, ISPs and account holders in two distinct ways: it establishes limits
on the government’s ability to require ISPs to disclose any information concern-
ing the accounts, without the consent of its holder, a subpoena or a warrant
and it also limits ISPs in disclosing information voluntarily to either government,
third party of any other entity.
When it comes to digital inheritance, the biggest problem lies in the fact that
SCA is not clear in respect whether it should apply to access to decedents’ ac-
counts and profiles. Banta (2014) accentuates that SCA does not even address
ownership of digital assets or its transfer, inter vivios or mortis causa, rather it
only addresses access to digital accounts or digital assets. Cahn (2014) ex-
plains the reason why SCA does not explicitly mention inheritance of digital
assets stored in an account: at the time of its enactment it was impossible
to predict that in the very near future, digital assets will be assets capable of
inheritance or will assist access to other digital assets. That is, according to
Cahn, the only reason why the legislators failed to explicitly allow inheritance
of digital assets stored on an account. However, according to Cahn (2014)
and Banta (2014), regardless of the fact that access to heirs is not explicitly
mentioned in SCA, it is certainly in accordance with its spirit, since its creators

42
never had heirs in mind when thinking about unlawful and unconsented access
to digital accounts. Cahn (2014) also notes that SCA was enacted long before
Facebook, Google or any of the most popular ISPs today, so its drafters could
not envision how digital assets would look. At the time of SCA’s enactment, they
were concentrated only on privacy issues of account holders, not really thinking
about devisability of digital accounts or assets. Because of this, Watkins (2014)
mentions that many commentators agree that SCA is outdated.
According to Cahn (2014) SCA could be interpreted in a way that will allow
access to heirs upon death of an account holder. However, it would be prefer-
able to amend it in a way that will define account holders’ ‘consent’ to include
instructions put in will that allow heirs to access digital accounts and assets.
Regardless of previously mentioned points of view, ISPs interpret chapter 2702
of SCA in a way that will minimize their potential liability. Borden (2014 a/b)
confirms this: in order to protect themselves, ISPs have chosen to adopt poli-
cies that do not allow anyone, other than the account holder, accessing his/her
account. As a result, since social media and e-mail providers chose to adopt
policies that do not allow accessing the decedent’s account, except in case of
one of SCA exceptions, e-mail and social media providers in almost all cases
prohibit anyone to access decedent’s accounts and profiles.
As Eichler (2016) also mentions, the most important exceptions to this rule
are – „consent exception“ (access is possible „with the lawful consent of the
originator or an addressee or intended recipient of such communication, or
the subscriber in the case of remote computing service“) (SCA, 1986, chapter
2072, section (b)) (3) and – „the court order exception“ („A governmental en-
tity may require the disclosure by a provider…. only pursuant to a warrant…“)
(SCA, 1986, Chapter 2073, section (a)). 3
Consent exception under SCA (1986) means that e-mail and social media pro-
viders can grant access to anybody who receives consent from the owner of
the account. It seems that according to this exception, it would be easy to make
a will and leave instructions on how to handle one’s digital assets after death.
However, various commentators found different issues with this claim. As Bor-
den (2014) states, most people do not make plans for their digital assets, since
social media users are usually young and as such, are less likely to think about
death and leave a will with an estate plan, let alone an estate plan containing
provisions on what is to happen with their digital assets after they die. Of course,
the same author emphasizes that there are a lot of older people who use e-mails
and social media, who tend to think about what will happen with their belongings
after they die, but even if they do make wills concerning their tangible property,
they do not plan for digital assets. Horton (2017), on the other side, altogether
questions whether a ‘lawful consent’ could even translate into the inheritance
context. He also makes a valid question: what will happen to digital assets of
intestate decedents who have done nothing to make their wishes known?

3 See these exceptions on: https://www.law.cornell.edu/uscode/text/18/2702 (last visited on

March, 30, 2018)

43
Cahn (2014) agrees that SCA does not explicitly address whether heirs have
lawful consent to access deceased’s digital account. However, as was already
mentioned, she states that upon analysis of SCA it is clear that it was meant to,
either, ban access to an unknown third party (i.e. a hacker) who wanted to do
harm to an account holder or benefit from his/her information, or ban access
to government bodies who wanted insight into someone’s account, without a
warrant, court order or such. Cahn calls it: ‘unwarranted government snooping’
(2014, p. 1713). This is essentially different from access of a person who is
named in a will as deceased’s heir and the one who is permitted by will to in-
herit said account. Therefore, according to Banta (2014), if a decedent leaves
instructions in his/her will concerning digital assets, ISPs should respect those
wishes without fear that they would be sued.
When it comes to court order exception under SCA, Edwards/Harbinja (2013),
Darrow/Ferrera (2007), Banta (2014), Cummings (2014), Horton (2017) and
most other authors that have dealt with the issue of digital inheritance, mention
the highly publicized Ellsworth case.4 This case demonstrated that social media
and e-mail providers will provide (limited) access to deceased’s digital content,
only if those seeking access obtain a court order that commands access. They
will, however, usually not grant access to the account itself (by providing log-in
information).
However, Borden (2014) and Varnado (2014) mention there are several prob-
lems pertaining to obtaining court orders to access digital content of the de-
ceased. First of all, it is neither cheap nor simple to obtain a court order. The
cost of litigation is considerable, and many people will not be able to afford it.
Furthermore, a huge number of e-mail and social media users whose service
providers are based in the U.S. and therefore governed by U.S. laws, do not
live in the U.S., so that complicates matters even more. Secondly, if family
members decide to obtain the court order, they might not get it on time, since
some social and e-mail sites have a deletion policy if the account is not used for
a certain period of time. Thirdly, according to Borden (2014), even after a court
order commanding access to deceased’s account is issued, it takes a while for
legal departments of social media and e-mail providers to process the request
and grant access. And after access is granted, the parties that asked for it might
not get what they expected, as was seen in Ellsworth case, where, Ellsworth’s
father, only got e-mails received by his son.
Banta (2014) also sees one big problem with the way this and many more
cases were resolved – regardless of the fact that a lot of people would want

4 After a U.S. marine Justine Ellsworth died, his family members wanted access to his Yahoo!
e-mail account. Since Yahoo!’s terms of service prohibit third parties from accessing someone’s
account, even if that someone is dead and it is his/her family members demanding access, the
case ended up in court. The judge ordered Yahoo! to enable access to the deceased’s account
without ordering the transfer of log-in and password information. That way, Yahoo! could still abide
to its privacy policy but family members could and did gain access to deceased e-mails. It was done
because the judge ordered Yahoo! to provide a family with a CD containing copies of the e-mails in
the account. However, they did not gain access to deceased’s e-mail account or log-in information.

44
their heirs to have access to decedent’s account, ISPs’ ToSA and positions on
account transfer post mortem stay the same. This presents a huge issue since
whenever heirs request access to deceased’s account, apparently, cases are
resolved on an individual level which is probably the worst way to resolve these
issues, since this severely contributes to legal uncertainty.
So, how do ISPs justify their contractual choices?
According to Banta (2014, p. 385), their justifications come down to adminis-
trative or cost concerns if they allow transfer of an account; concerns about
protecting account holders’ privacy and their apprehension that devisability of
digital assets would be against the law. However, in Banta’s opinion, these
reasons do not justify such measures of prohibiting or limiting transfer of digital
assets, and the same author gives comments to each of these concerns.
When it comes to administrative or cost concerns, while Horton (2017) agrees
with this justification, Banta notes that ISPs could require heirs who want ac-
cess to the deceased’s account to pay a fee. Also, nobody should expect ISPs
to keep a deceased’s account on its servers indefinitely – they can keep it for a
certain period of time which is enough for heirs to access it and delete it later.
When it comes to protection of privacy, which is the main reason for ISPs’ refus-
al to heirs accessing deceased’s accounts, Banta states that ISPs are not the
ones that need be concerned with the privacy of a deceased account holder,
since his/her privacy died with him (see also Banta, 2016). It is not up to them
to decide how to protect account users’ privacy. Furthermore, according to the
same author (2014), deceased’s privacy is not of a concern when it comes to
his/her tangible items, such as letters and photos, which are regularly inherita-
ble after the death of their owner. There is no reason that digital assets should
receive greater protection.
Third concern of ISPs is that they will be breaking the law (SCA) if they let an-
yone other than the account holder access an account (for example, Facebook
and Yahoo! were the ones to specifically cite SCA when they refused to give
access to deceased’s account heirs. See case law in Banta, 2014). However,
after analyzing SCA, Banta (2014) and Cahn (2014) pointed out that this law
was never meant to apply to transfer of digital assets to deceased’s heirs since
it was never meant to prevent this type of transfer. Rather, it was meant to
prevent access to third parties such as government bodies or hackers, who
wanted to gain unconsented and illegal access to someone’s account. Also,
this seems like an empty claim, since Banta (2016, p. 964) emphasizes that no
ISP has ever been prosecuted for violating SCA after releasing the contents of
a decedent’s account to family members. Banta (2014, p. 829) also states that
the decision to prohibit inheritability of digital assets only benefits ISPs because
it lets them avoid administrative hassle and promote more use and purchase
of their products.

45
2.3. Solutions according to Google’s Gmail and Facebook
As Brubaker and Callison-Burch (2016) note, if decedents leave their log-in
information to their heirs, it is done outside of system design and policy of ISPs.
To resolve this, Gmail and Facebook addressed the issue by allowing account
holders to decide who, if anyone, will have access to information stored on their
accounts and what should be done with the account itself after they die (Horton,
2017). Apparently, as Lopez (2016) indicates: it seems the pressure for access
to online accounts and information after its holder dies, directly affected chang-
es in policies of (at least some) ISPs.
Both Google and Facebook in their ToSA state that they do not own account
content, it belongs to an account user: Google – “Some of our Services allow
you to upload, submit, store, send or receive content. You retain ownership
of any intellectual property rights that you hold in that content. In short, what
belongs to you stays yours.“5 Facebook – „You own all of the content and in-
formation you post on Facebook, and you can control how it is shared through
your privacy and application settings.”6
However, Facebook ToSA under ‘Registration and Account Security’ part of its
ToSA explicitly states: “You will not share your password (or in the case of
developers, your secret key), let anyone else access your account, or do an-
ything else that might jeopardize the security of your account. …You will not
transfer your account (including any Page or application you administer) to an-
yone without first getting our written permission.”7 Google, on the other hand,
is not as straightforward when it comes to Gmail account, but in their ToSA
they clearly state: “To protect your Google Account, keep your password con-
fidential. You are responsible for the activity that happens on or through your
Google Account.8

2.3.1. Facebook – deletion, memorialization or Legacy Contact

As Carroll (2018) explains, Facebook, unlike many other ISPs, has three fea-
tures that deal with the death of an account holder – memorialization of an
account, Legacy Contact and deletion after Facebook is notified of account
holder’s death. However, as Brubaker/Hayes/Dourish (2013) mention, deletion
is probably the least preferable option because most account holders often
underestimate what these accounts mean to their family and friends. Arnold
(2016) and Fearon (2011) mention that social media is often used as a coping
mechanism for deceased’s family and friends. Nowadays it is common, after a
person dies, for his/her family and friends to post their sentiments on Facebook.
Deceased’s friends and family sometimes even set up new online venues that
serve as an emotional outlets.

5 https://www.google.com/intl/en/policies/terms/ (last visited on March 30, 2018).

6 https://www.facebook.com/terms.php (last visited on March 30, 2018).
7 https://www.facebook.com/legal/terms (last visited on March 30, 2018).
8 https://www.google.com/policies/terms/ (last visited on March 30, 2018).

46
Borden (2014, p. 413) explains that first time Facebook actually became a cop-
ing mechanism was in 2007 after Virginia Tech Massacre. Prior to it, Facebook
deleted accounts after it learned about user’s death. However, friends and fam-
ily of victims urged it to adapt its policy concerning deletion of an account.
As Brubaker and Callison/Burch (2016) mention, 2007 was actually the year
that brought Facebook’s oldest feature concerning account user’s death – ac-
count memorialization (for more about memorial groups and memorialization,
see Fearon, 2011; Moncur/Waller, 2014). As is stated in Facebook: What will
happen to my account if I pass away?9 after Facebook account holder dies
and Facebook is notified of it, they will memorialize an account, meaning that
the profile will remain viewable under the same privacy setting as earlier, but
no one will be able to access it or change it in any way; a word ‘Remembering’
will be added to decedent’s name; memorialized profiles will not display any
advertising and can be excluded from features such as ‘People You May Know’
or birthday reminders.
Brubaker and Callison-Burch (2016) point out that, although there have been
many straightforward requests for memorialization, there were some that were
exceptionally complex (father wanting to connect to his deceased son’s profile,
but was not ‘friends’ with him on Facebook; mother wanting to change her de-
ceased daughter’s profile photo to something more appropriate...). Facebook
had no way of knowing what the deceased would have wished (Would the son
want his father for a Facebook friend? What would the daughter find appropri-
ate for a profile photo?). Therefore, Facebook started thinking about introduc-
ing a new feature that will take into consideration the deceased’s wishes.
According to same authors (2016, p. 2-3), there are three different ways to deal
with decedent’s account, other than deleting it or letting it stay indefinitely on
servers, without anybody being able to access them: 1. Configuration-based
approach – ISP could leave it to an account holder to decide what will happen
with his/her account post mortem (for example, there is ‘IfIDie’ application for
Facebook users that lets them decide what the system should do after they
die)10; 2. Inheritance-based approach – account holders could leave log-in in-
formation to their heirs and hope ISPs will not notice or 3. Stewardship-based
approach – ISPs could let an account user choose a person to care for both
needs of the deceased and the community.
Brubaker/Callison-Burch (2016) state that Facebook opted for the latter – in
2015 they introduced a new feature called Legacy Contact. Facebook did this,
because memorialization option was underutilized; the reasons being the lack
of public awareness, little incentive to memorialize an account (since after me-
morialization, an account is excluded from many other Facebook features) and
because most of decedent’s Facebook friends were unsure whether it was ap-
propriate for them to submit a request for memorialization, if close family mem-
bers neglected to do so themselves.

9 https://www.facebook.com/help/103897939701143/?__tn__=%2As-R (last visited on March

30, 2018).
10 http://ifidie.net/ (last visited on March 30, 2018).

47
Linishi (2015) adds mentions that Legacy Contact was made according to wish-
es of different decedent’s family members that turned to Facebook with re-
quests to gain access to deceased’s profile and download data or post funeral
information etc.
Legacy contact settings can be accesses through Security section in account
settings. According to Brubaker and Callison-Burch (2016), it has three fea-
tures that all legacy contacts have and one optional eature that will only come
into force if an account holder opts for it. Chosen legacy contact will never be
able to log in as the person who died or see their private messages.
These authors explain:
Primary features are: 1. Legacy contact can post on decedent’s Wall whatever
information they want (or were instructed to, by decedent). For example: infor-
mation concerning user’s death, memorial service information, final words etc.
These posts will always be at the top of the profile, so Facebook friends will not
have to search for them somewhere on the Wall, like they have to on memo-
rialized profiles. 2. He/she will be able to change profile or cover photo and 3.
Accept or deny friend requests made post mortem. Fourth feature is optional
– account holders can grant legacy contacts the permission to archive data on
his/her account (photos, posts, videos…).

2.3.2. Google – request for a deceased person’s account

or Inactive Account Manager
As Cummings (2014) stated not very long after Google launched its ‘Inactive
Account Manager’ (IAM), it is the only policy that is consistent with SCA be-
cause an account holder who finds and participates in Gmail process, has
clearly indicated circumstances under which he/she consents to access of third
party to his/her account post mortem. Regardless of the fact that a lot of Gmail
account holders are still probably unaware of IAM feature, it is the only effective
way to determine the intent of the deceased concerning his/her Gmail account.
IAM has existed since 2013 and it lets Gmail account holders choose a person
who will be granted access to their data, after they die and their account be-
comes inactive. According to Google rules, an account user needs to log in to
his/her Gmail account and set an alert notification method (a phone number)
and a time out period, which can be 3, 6, 12 or 18 months of inactivity. Google
will alert an account holder multiple times by SMS, or e-mail, one, two or three
months before that period expires, depending on the length of inactivity an
account holder chose. After an account user chooses a time out period, he/she
will have to add „trusted contacts” who will be notified that his/her account has
been inactive for a chose period of time. Account user can even share his/her
data with „trusted contacts“. For example, he/she can choose to send Gmail
messages to one person and Google Drive documents to someone else.

48
Account user can, additionally, set his/her account to be deleted after the cho-
sen period on inactivity has passed.11
Steps to set up IAM are, as follows:
Step 1: Decide when Google should consider your Google account
inactive - an account holder can choose between four options – 3, 6, 12 or
18 months of inactivity. This period starts with the last sign-in. IAM alerts an
account holder on multiple instances via SMS or email.
Step 2: Choose who to notify & what to share – an account holder chooses
trusted contacts and decides whether he/she wants to share data with them.
Step 3: Optionally delete account – alternatively, an account holder can
instruct Google to delete his/her account.12
Lamm (2013) adds that the difference between IAM and Facebook Legacy
Contact is that Gmail account users can choose up to ten „trusted contacts“.
The reason Google opted for this alternative is because the person designated
to receive account holder’s data may not be able to receive it because they
changed e–mail accounts, phone numbers, because they are incapacitated or
also deceased.
If an account holder failed to utilize IAM, Google offers his/her family members
another possibility:
„Make a request for a deceased person’s account
We recognize that many people pass away without leaving clear instruc-
tions about how to manage their online accounts. We can work with im-
mediate family members and representatives to close the account of a
deceased person where appropriate. In certain circumstances we may
provide content from a deceased user’s account. In all of these cases,
our primary responsibility is to keep people’s information secure, safe,
and private. We cannot provide passwords or other login details. Any
decision to satisfy a request about a deceased user will be made only
after a careful review.
What would you like to do?
Close the account of a deceased user
Submit a request for funds from a deceased user’s account
Obtain data from a deceased user’s account”13

11 https://support.google.com/accounts/answer/3036546?hl=en (last visited on March 30, 2018).

12 https://myaccount.google.com/inactive (last visited on March 30, 2018).
13 https://support.google.com/accounts/troubleshooter/6357590?visit_id=1-636571564316645775-
2493820124&rd=2 (last visited on March 30, 2018).

49
3. Methodology
Although the title and the main topic of this paper are Google and Facebook
accounts and what happens to them after their holder dies, it was first important
to research background behind these and other ISPs rules about non-transfer-
ability of an account. It has to be stressed that neither Google nor Facebook,
prior to the solutions mentioned in this paper, had any different rules on account
transferability, than most other ISPs. Therefore, the first part of the research
was focused on why some of the most popular ISPs that are based in the U.S.,
but are largely used all over the world (including Croatia), have such similar
rules concerning non-transferability of an account inter vivos or mortis causa.
The second part of research was directed at analyzing possible solutions to this
problem, both in literature and in specific ISPs options offered to their clients
(Google and Facebook).
The research was first directed at finding where ISPs’ rules on non-transfera-
bility are found. Since they are mainly placed in ISP’S ToSA, to find out what
these agreements state about what will happen to an account after its holder
dies, specific ToSA and available commentators’ views on these agreements
were researched. Those commentators speculations and solutions on how to
resolve the issue of (too) great of an impact ToSA have on basic principles of
ownership and succession law, were analyzed. While researching ToSA, the
author investigated what different commentators had to say about different
types of ToSA, their enforceability, validity and provisions that directly affect
succession law (Banta, 2014,2016, 2017; Cahn, 2014; Cummings, 2014; Dar-
row/Ferrera, 2007; Eichler, 2016; Klarić/Vedriš, 2014; McCarthy, 2015; Ron-
deros, 2014; Sherry, 2012; Tarney. 2016; Truong, 2009; Varnado, 2014; Wat-
kins, 2014;https://www.facebook.com/terms.php; https://www.google.com/intl/
en/policies/terms/)
Since all U.S. based ToSA analyzed in this paper have similar provisions about
non-transferability of accounts, directly or indirectly incorporated in ToSA, the
research proceeded to find the reason behind this. Therefore, the legislation
that governs ISPs account transfer was researched and its impact on these
agreements. Also, since ISPs claim that said legislation prohibits account
transfer, unless specific exceptions exist, the research then dealt with the most
important exceptions that might allow account transfer (Banta, 2014; Borden,
2014; Cahn, 2014; Eichler, 2016; Horton, 2017; Varnado, 2014; Watkins, 2014;
Electronic Communications Privacy Act; Stored Communications Act; Omnibus
Crime Control and Safe Streets Act).
Because most commentators and public (as was discovered in literature and in
case law) criticized existing solutions and requested change, the final part of the
research proceeded to analyze Google’s and Facebook’s solutions to this prob-
lem, that are more in accordance with basic principles of succession law. These
solutions were analyzed themselves and also various commentators specu-
lations on them (Arnold, 2016; Borden, 2014; Brubaker/Hayes/Dourish, 2013;

50
Brubeker/Callison-Burch, 2016; Caroll, 2018; Cummings, 2014; Fearon, 2011;
Horton, 2017; Lamm, 2013; Linishi, 2015; Lopez, 2016; Moncur/Waller, 201414).

4. Empirical data and analysis

ToSA are contracts of adhesion that govern the relationship between an ISP
and an account holder (Darrow/Ferrera, 2007; Ronderos, 2014). There are
a few commentators who question their enforceability because of their form,
length, vagueness and the fact that they are solely defined by an ISP (Banta,
2014; McCarthy, 2015; Ronderos, 2014; Sherry, 2012; Varnado, 2014). Oth-
ers claim that clickwrap agreements are enforceable, while browsewrap might
not be, which they corroborate with case law (Banta, 2014; Ronderos, 2014)).
However, ToSA are binding contracts between an account holder and an ISP,
regardless of the fact that most account holders do not even read them (Mc-
Carthy, 2015).
Furthermore, commentators agree that ToSA severely limit, not only interests
of ownership, but also freedom of testation (Banta, 2014, 2016, 2017; Bor-
den, 2014; Darrow/Ferrera, 2007; Troung, 2009; Ronderos, 2017). They are
sometimes silent about, but mostly are against, account holders exercising cer-
tain ownership interests and transferring their account after they die. (Banta,
2014, 2017)
They all agree that one of the reasons for the impact ToSA have on ownership
of an account, its content and its (un)inheritability today, stems from ISP’s inter-
pretation of a thirty year old law – SCA which, many commentators emphasize,
was never meant to prevent succession of said accounts (Banta, 2014; Borden,
2014; Cahn, 2014; Horton, 2017; Varnado, 2014; Watkins, 2014). One of the
most important provisions of SCA for this paper is found in its chapter 2702,
which prohibits electronic service providers and remote computing services
from disclosing account content to unauthorized individuals.15 It was concluded
that SCA is not clear in respect whether it should apply to estates accessing
deceased users’ accounts, but that private social media and e-mail providers
have chosen to interpret it in such a way that will minimize their potential li-
ability. Most commentators agree that, in order to protect themselves, ISPs
have chosen to adopt policies that do not allow anyone, other than the user,
accessing the deceased user’s account, regardless of the fact that most agree
SCA was never meant to prohibit access to decedent’s heirs (Banta, 2014;
Borden, 2014; Cahn, 2014; Watkins, 2014). There are some exceptions to this
rule – consent exception and a court order exception, being the most important
for this paper and these might explain why some ISPs have allowed heirs to
access a decedent’s account.

14 Also: https://www.facebook.com/help/103897939701143/?__tn__=%2As-R (last visited on

March 30, 2018).
https://support.google.com/accounts/answer/3036546?hl=en (last visited on March 30, 2018).
15 https://www.law.cornell.edu/uscode/text/18/2702 (last visited on March 30, 2018).

51
Some commentators agree that inheritance of digital assets stored on ISPs
accounts could be allowed if ISPs allowed account users to choose what they
wanted done with their account post mortem, which would be in accordance
with SCA ‘consent exception’ (Banta, 2014, 2016; Hopkins; Sherry, 2012; Tar-
ney, 2012). Google’s Inactive Account Manager and Facebook’s Legacy Con-
tact are presented as good examples of how ISPs themselves might resolve
this issue, without exposing themselves to liability for breaking the SCA.

5. Results and discussion

ToSA might differ from an ISP to an ISP, but as was shown earlier, most of them
regulate important issues like transferability of an account inter vivos or mortis
causa similarly – they do not allow it, at worst, or are silent about it, at best.
Since most of them deal with this matter in the same way, this means they do
not offer any real alternative to account holders (Banta, 2014). Regardless of
the fact that ToSA are seldom read and those who do read them, usually do not
read all of them, they are binding contracts that regulate relationship between
an account holder and an ISP, (McCarthy, 2015).
From analysis of different commentators points of view and solutions offered by
various ISPs, it can be concluded that, until legislation changes and expressly
allows transferability of digital accounts and its content to decedent’s heirs,
which will in turn make changes to ToSA concerning the same issue possible,
the best solution is for account holders to address this issue with an ISP they
have an account opened with (Banta, 2014, 2016; Hopkins; Sherry, 2012; Tar-
ney, 2012; Truong, 2009). This is only possible if that ISP offers this possibility
to its clients. Most do not, but Google and Facebook, arguably some of the
most popular e-mail and social media providers, do.
However, what was discovered while researching Google’s and Facebook’s
solutions is that features which let account holders decide what will happen to
their accounts post mortem are not mentioned anywhere in Gmail or Facebook
ToSA. They are located in their respective help forums. Because of that, future
account holders could read ToSA word for word, but they would still not be
aware of these features, unless they specifically knew where to look for them
(Cummings, 2014). This might be a problem since both Google and Facebook
ToSA, either directly or indirectly, state that passwords must not be revealed
to anybody and that accounts are not transferrable. So, an account holder
that has consented to Google and Facebook ToSA might believe that there
is nothing he/she can do if he/she wants an account or its content transferred
post mortem.
This is the main problem encountered concerning these solutions. Most com-
mentators (i.e. Banta 2014, Ronderos, 2017) agree that browsewrap agree-
ments, which display the rules to future account holders, but do not require
them to click that they agree, should not be enforceable if future account hold-
er did not have actual or constructive knowledge of the terms or conditions.

52
One can ask, how is putting certain features in such unenforceable agreements,
different from putting them in various help forums? In both cases account users
will have a hard time finding them and no way of consenting to them.
Therefore, since not knowing about these features, account holders will not
activate them and all their digital conten stored on their accounts might be lost
to their heirs forever, because without these features, their accounts will be
considered non-transferrable and heirs will probably not be able to gain access
to any of their content.
It has to be noted that, while researching for this paper, the author knew a lot
about these possibilities and where to look for them, but still had a hard time in
finding them because they are dispersed all over Google and Facebook sites.
For an average user, that has no idea these features even exist, it might be
close to impossible to become aware of them, let alone find them.

6. Conclusion
It might seem morbid und mundane to think about what will happen to one’s
digital account post mortem, when there are much more pressing problems the
world is facing today. But, death has always been a significant legal fact and
has always had a big impact on civil law, especially on inheritance. Also, digital
accounts are now becoming places that hold a tremendous amount of data
about ourselves and the world around us. Most of the items that were once
tangible now exist only in a digital form and many of them are stored on on-line
accounts. One can say that our lives have become tremendously digitized and
our digital assets have great emotional and monetary value. However, all of
that wealth is, according to the rules of those who hold it, not ours to dispose
as we would want.
Since ISPs’ ToSA prohibit account inheritability and, under existing legislation, it
seems this will not change soon, other solutions had to be found. Account users
could try to put preassure on ISPs to do something about it, but it is not certain
whether they will succeede. However, public preassure seemd to have given
some results: two of the most popular e-mail and social media providers have
adopted solutions to help their clients choose what, if anything, will happen to
their accounts after they die. After a thorough analysis, it seems this is the only
soluiton that will appease both account users and ISPs and one can only hope
that the rest of the providers will decide to follow this example.
The only problem with existing solutions is that because they are not visible,
account users are, at present, unlikely to found them.

53
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Watkins, A.F.: Digital Properties and Death: What Will Your Heirs Have Access
to After You Die?; Buffalo Law Review, Vol. 62/2014

Legal sources:
Electronic Communications Privacy Act, 1986;

Justice Information Sharing: https://it.ojp.gov/PrivacyLiberty/authorities/

statutes/1285

Stored Wire and Electronic Communications and Transactional Records

Access, 1986;

Legal Information Institute: https://www.law.cornell.edu/uscode/text/18/part-I/

chapter-121

Omnibus Crime Control and Safe Streets Act, 1968;

https://transition.fcc.gov/Bureaus/OSEC/library/legislative_histories/1615.pdf

Law of Obligation, National Gazette, 35/05, 41/08, 125/11, 78/15

Internet sources:
https://www.facebook.com/terms.php

https://www.facebook.com/help/103897939701143/?__tn__=%2As-R

https://www.facebook.com/help/250563911970368?helpref=hc_global_nav

https://www.google.com/intl/en/policies/terms/

https://support.google.com/accounts/answer/3036546?hl=en

http://ifidie.net/

56
 CHAPTER 3

Electronic signature in legal theory

and practice - new regulation

Davorin Pichler1, Dražen Tomić2

ABSTRACT

In the Republic of Croatia, electronic signature is subject to the regulation of a statute

which regulate the implementation of European legislation on electronic identification
and trust services for electronic transactions. The goal of the paper is to identify and
estimate the new EU legislative framework for electronic identification and a new system
of regulation and supervision for electronic service providers in the EU, which should
stimulate electronic commerce and cross-border digital public services. This regulation
places particular emphasis on the recognition of electronic identification means between
Member States for cross-border authentication, personal data security and the supervi-
sion of qualified providers of trust services. Using the normative and institutional anal-
ysis of national legal source, as research method in the paper, has helped to identify
the typical problems that arise in regulating electronic signature. We find that the results
imply that, despite the optimism that using electronic signatures can have a significant
impact on e-finance, cybercrime is a growing threat. Commercial operators only become
aware that the electronic signature methods they use must be adequate and that certain
criminals can even „break“ the two-degree authentication process. Professional users
and consumers needs continuous education to keep pace with the fraudsters.

Keywords: electronic signature, manifestation of will, authentication,

public key

JEL classification: K12, K15

1. Introduction
Legal transaction is a manifestation of will directed towards the achievement
of permitted legal effects, among which the most important is the occurrence,
change or termination of a civil law relationship (Klarić and Vedriš, 2006: 107)3.
In the Republic of Croatia, the Obligatory Relationship Act, in article 249, par-
agraph 1, regulates the ways in which will for conclusion a contract may be
declared, stating that the willingness to conclude a contract may be expressed
by words, usual signs or other behavior from which it can be concluded with
1 Assistant Professor, Faculty of Law, University of Osijek..
2 Bureau of Informatics Osijek.
3 This definition of legal transaction is emanation of the principle of consensuality of contracts in
contemporary civil law regulations. (Crnić, 2006: 246).

57
certainty about its existence, content and identity of the statement provider (Ob-
ligatory Relationship Act, 2005). Thus, from the form of manifestation of will it
must be manifestly: the existence and content of the statement, and the identity
of the person which declare will (Klarić and Vedriš, 2006: 127). Paragraph 2,
article 249 of Obligatory Relationship Act provides the possibility of giving a
statement of will through various means of communication, which is in fact
related to statements of will given electronically (Obligatory Relationship Act,
2005). In the explanation of the Final Proposal of the Obligatory Relationship
Act it is stated that in this way, in line with the trend that is present in the for-
eign legislations, is eliminated the doubts thats occur in practice regarding the
use of modern telecommunication means for concluding the contract (Crnić,
2006: 248). The tendency is that the electronic manifestation of will is equal to
the written form. Thus also article 292 paragraph 4 of Obligatory Relationship
Act stipulates that the requirement of a written form of contract is fulfilled even
where the contracting parties enter into agreements by means which enable
it to establish with certainty the content and identity of the statement provider
(Obligatory Relationship Act, 2005). The written manifestation of will is valid
only when it is signed. The signature in itself contains the presumption that in
the text is expressed true will of the signatory. Valid signature is that which does
not put in doubt the identity of the signatory (Klarić and Vedriš, 2006: 128). Al-
though, basically, between the conclusion of the contract electronically and the
contracts concluded in another way there is no substantive difference, since the
contract is in any case an agreement (Crnić, 2006: 287), article 293 paragraph
3 of Obligatory Relationship Act suggests that electronic signature is subject of
a special regulation4.

2. Concept and use of electronic signature

Understanding the terms “signature” and “confirmation” is different in the legal
theory and practice of common law and the continental European legal system.
The countries of the continental European legal system apply the principle of
non-formalities, which means that the contract does not have to be concluded
and signed in writing form to be valid. The common law system, over the past
150 years, has passed the evolution of the concept of “signatures” from the
emphasis on form to focus on the function. It can be said that the courts in the
common law system are focus on the parties’ intent, rather than on the form
of their signing act (UN Commission on International Trade Law, 2009: 3). Ob-
ligatory law in the Republic of Croatia accepted the principle of non-formalities
of the contract. In that sense, the obligation arises because of content that is
desirable, not because of the form in which the content is expressed (Klarić and
Vedriš, 2006: 131).

4 Aforecited article of Obligatory Relationship Act stipulates that the use of an electronic signa-
ture in stipulating of the contract is regulated by a special regulation. (Obligatory Relationship Act,
2005).

58
As stated, electronic signing in the Republic of Croatia are regulated by a spe-
cial regulation. The Implementing Act of Regulation (EU) No. 910/2014 of the
European Parliament and of the Council of 23 July 2014 on electronic identifi-
cation and trust services for electronic transactions in the internal market and
repealing Directive 1999/93/EC5, in article 2 paragraph 1, with regard to the
terms used in The Implementing Act of Regulation (EU) No. 910/2014, refers
to the meaning of the terms in Regulation (EU) No 910/2014 of the European
Parliament and of the Council of 23 July 2014 on electronic identification and
trust services for electronic transactions in the internal market and repealing
Directive 1999/93/EC6, which regulates electronic identification and electron-
ic transactions, and whose implementation is regulated by The Implementing
Act of Regulation (EU) No. 910/2014. In that sense, the meaning of the term
electronic signature, The Regulation (EU) No 910/2014 is provided in article 3
item10, by specifying it as electronic data that is associated or logically linked to
other electronic data and which the signatory uses to sign (Council Regulation
(EU), 910/2014) 7, 8, 9.
However, the same value as handwritten signature has a qualified electron-
ic signature (Council Regulation (EU), 910/2014, (25)). Qualified electronic
signature means an advanced electronic signature that is generated by qual-
ified10 means for generating of electronic signatures and is based on a quali-
fied electronic signature certificate (Council Regulation (EU), 910/2014, (3)).
An advanced electronic signature is an electronic signature that meets cer-
tain requirements. These requirements are prescribed by The Regulation (EU)
No 910/2014, article 26, which defines as an advanced electronic signature the
one which is unambiguously linked with the signatory, enables identification

5 Hereinafter The Implementing Act of Regulation (EU) No. 910/2014.

6 Hereinafter The Regulation (EU) No 910/2014.
7 One data in electronic form contains a message (manifestation of will) and in a second data is
signature in electronic form that serves for the authentication of the first. (Nikšić, 2000: 255).
8 In the legislation of United States of America, the Electronic Signature in the Global and National
Commerce Act defines the electronic signature as “any electronic sound, symbol, or process as-
sociated with an agreement and executed with the intention of signing an agreement”. Apart from
being in digital form, the electronic signature is legally identical to a, handwritten signature and
carries the same authority and credibility as John Hancock’s name on the Declaration of Independ-
ence. Electronic signatures in the United States, Legal considerations and best practices. (Adobe
Systems Incorporated, 2017).
9 The oldest act that contains definition of an electronic signature is the Digital Signature Act of the
U.S. Utah state from year 1995, which states that the electronic signature should be implemented
in order to link legal effects to its use. (Katulić, 2011).
10 Qualified means for generating electronic signature shall, by appropriate technical and proce-
dural means, ensure that the confidentiality of the electronic signature creation data, used to create
an electronic signature, is reasonably ensured, that the electronic signature data used for electronic
signature can practically be appear only once, that the electronic signature data used to generate
an electronic signature can not, with a reasonable degree of confidence, be derived from it, and
that the electronic signature is reliably protected against counterfeiting using the currently available
technology, that the lawful signer can reliably protect electronic signature data used to generate
electronic signature from use by other persons. Qualified means for generatig electronic signatures
may not change data that is signed or prevented from displaying such data to the signatory before
signing it. (Council Regulation (EU), 910/2014, (Annex II))

59
of the signatories, was made by using data for generatig electronic signature
which the signer may use with a high level of trust under his exclusive control
and is associated with the signed data so that any subsequent data changes
can be detected.
The legal and business practice in the contracts concluded in electronic com-
munication recognize the character of the written form, and thus the electronic
signature undoubtedly gains the meaning of the traditional signature (Matić,
2000: 267).. In this respect, legal transaction in the electronic form is consid-
ered as a special form, an external manifestation of the content of a particular
legal transaction (Klarić and Vedriš, 2006), which, by its legal effects, is aligned
with the written form of legal transaction11. So in electronic business, with use
the advanced electronic signature, memorandums and stamps are unneces-
sary and inadequate (Matić, 2002: 274).

3. Promoting security in electronic business

More and more use of information technology has enabled remarkable growth
of the branches of the economy wich used electronic commerce, and the de-
velopment of commerce through the Internet accelerates the development of
other technologies such as electronic money transfer, internet marketing, auto-
mated storage and data analysis (Katulić, 2011: 1340). More than 315 million
Europeans use the Internet on a daily basis, and the common European market
is open to more than 500 million consumers. However, less than 4% of online
services are offered across national borders, meaning that business, with its
goods and services, only reaches a limited number of populations. A small per-
centage of consumers buys online from one EU country to another, and even
fewer entrepreneurs risk trading on the Internet to a cross-border customers.
This situation suggests that at EU level there is a need for a policy that, with
the aim of launching the economic recovery of the European Union, will quickly
remove obstacles to electronic business (Woolfson and Terruso, 2015: 1).
In this respect, the European Commission began work on the new european
regulation for trust and security of electronic transactions in 2011. The work
was culminated in the new The Regulation (EU) No 910/2014. (Woolfson and
Terruso, 2015: 1).

4. New European regulation

The Regulation (EU) No 910/2014 sets a new legislative framework for elec-
tronic identification and a new regulatory and control system for electronic ser-
vices providers in the EU. This regulation should encourage electronic com-
merce and cross-border digital public services. I
11 This distinction is solely theoretical, because in practice this distinction is of no significance. It
is important that legal transaction produces the same effect as the traditional written form. (Matić,
2002: 275).

60
n summary, The Regulation (EU) No 910/2014 provides:
-- The legal effects of advanced electronic signatures, seals, electronic
seal certificates, time stamps, and tools for generating electronic seal.
-- The legal framework for authenticating12 web pages
-- Fundamentals for identification scheme of electronic identification means
between Member States for the purpose of cross-border authentication.
-- Personal data security and application requirements for all trust providers13
-- Supervision of qualified service providers (Woolfson and Terruso, 2015).
The Regulation (EU) No 910/2014 is applicable from 1 July 2016 (Council Reg-
ulation (EU), 910/2014, (52)). As a regulation, it applies directly in the Member
States without the need for national legislative measures.

4.1. Electronic signature protection and user identity verification

In order to be able to identified signatory with electronic signature (ensuring
the authenticity of the information) and confirm the authenticity of the signed
electronic record (ensuring the integrity of the information), in a way that such
signature has the same legal force and the possibility of replacing the handwrit-
ten signature and imprint of the stamp in the Republic of Croatia, based on Eu-
ropean regulation of electronic transactions, is used advanced electronic signa-
ture. An advanced electronic signature must ensure connectivity solely with the
signatory, must undoubtedly identified signatory, must be generated by the use
of means solely under the supervision of the signatory and must include direct
linkage with the data it relates to in a manner that undoubtedly enables access
to any modification of source dana (Council Regulation (EU), 910/2014, (26)).
In doing so, a qualified certificate is used to produce an electronic signature,
which represents an electronic confirmation by which a provider of services
issuing qualified certificate certifies an advanced electronic signature. Realiza-
tion of electronic and advanced electronic signature is possible by using Public
Key Infrastructure14 which is based on the application of an asymmetric cryp-
tographic system whereby PKI enables reliable authentication in the process of
applying to electronic services as well as protection of authenticity, integrity and
confidentiality of information. The PKI manages the generation and distribution
of the public and private key, the life cycle of the certificate, and publishes the

12 Authentication means an electronic procedure that allows the electronic identification of a nat-
ural person or legal person or the authenticity or integrity of the data in electronic form to be con-
firmed. (Council Regulation (EU), 910/2014, (3)).
13 The Regulation (EU) No 910/2014 in article 3 item 14 specifies a trust service as an electronic
service that is normally provided for compensation and consists of:
(a) Creating, verifying and validating electronic signatures, electronic stamps or electronic time
stamps, electronic recommended delivery services, and certificates relating to those services; or
(b) Creating, verifying, and validating certificates for authenticating web pages; or
(c) Preservation of electronic signatures, seals or certificates relating to those services.
14 Hereinafte PKI.

61
certificates in the directories. The PKI requires a tripartite trust in which two
sides trust each other, even though they have not previously established a busi-
ness or personal relationship, since each of them has established a relationship
with a third party that is a guarantor for establishing trust between the first two
sides (National PKI, 2004: 1).
Therefore, for security reasons, strict measures for the protection of advanced
electronic signature as well as the measure of user identity verification are de-
termined. The European Commission by implementing acts prescribes the con-
ditions for the means used for the generation of an advanced electronic signa-
ture, which must ensure that the data for generation of an advanced electronic
signature can only appear once and that their security has been achieved, that
the advanced electronic signature is protected against counterfeiting with using
the existing available technology and that the data of an advanced electron-
ic signature signer can reliably protect against the use of others. Also, The
Regulation (EU) No 910/2014 stipulates that means for the generation of an
advanced electronic signatures must not, during making change the data that
is signed or disable access to that data before the process of creating an ad-
vanced electronic signature (Council Regulation (EU), 910/2014, (Annex II)).
Certification service providers must provide the recipient of the electronic mes-
sages which is signed by electronic signature or another authorized person,
inter alia, to enable data verification of electronic signature and enable to reli-
able determine content of the signed data. As it is clear from the above, there
are three sides in the process of using the electronic signature: the certification
service provider, signatory and recipient of an electronic messages signed by
electronic signature and a computer-communication system that allows data
exchange between the three sides, it is necessary in all four of these segments,
to ensure the security of the electronic signatures. In addition to the legislative
framework, the area of electronic signature security is also defined by the secu-
rity procedures of the certification service providers.

4.2. Responsibility for damage

Although the technical norms and standards, as well as the prescribed tech-
nical and technological procedures for electronic signature design and imple-
mentation, ensure an adequate level of confidentiality, completeness and avail-
ability of dana, from a legal determination that the qualified certificates service
provider is required to insure the risk of liability for damages caused by per-
forming certification services through mandatory insurance, it is clear that there
is a risk in using the electronic signature. This is also confired by the possibil-
ity that the issuer of means of electronic identification respond to the damage
which he caused to natural and legal persons, by a transfrontier transactions,
by disregarding the obligation that personal identification data undoubtedly rep-
resent the person concerned, and that the party carrying out the authentication
process is responsible for the damage caused to the natural or legal persons,
in a transfrontier transaction, in breach of the obligation to perform authenti-

62
cation in such a way that any trustworthy party15, established in the territory
of another Member State, can confirm personal identification data received in
electronic form (Council Regulation (EU), 910/2014, (11)). Also, trust service
providers are responsible for damage caused intentionally or by negligence to
any natural or legal person by disregarding obligations under The Regulation
(EU) No 910/2014 (Council Regulation (EU), 910/2014, (13)) 16 17. The liability
of certification services provider may, under The Regulation (EU) No 910/2014,
be restricted so that trust service providers determined the limits to the use of
the services they provide, and they are not liable for damages related to the
use of services that exceed such limitations. The financial risk that providers of
trust services can bear on the basis of liability for damages is covered by the
insurance policies. In this regard, the certification service provider, in the qual-
ifying certificate, may indicate the limit of the value of the transaction for which
the certificate may be used and which option in the Republic of Croatia has
been used by two of the three trust services providers (Ministry of Economy,
2013)18. Users of the trust services should be adequately informed of the limi-
tations of liability for damage, eg. by including informations on the limitation of
liability in to terms of transactions19. Also, The Implementing Act of Regulation
(EU) No. 910/2014 also prescribes misdemeanor provisions for natural persons
who unauthorized access and use data and means for generating of electronic

15 A trusted party means a natural or legal person which relies on a electronic identification or a
trust service. (Council Regulation (EU), 910/2014, (3))
16 Cited articles that defining liability for damage determine that liability relations are governed
by national liability rules. In this respect, we can conclude that the application of the rules on
liability based on fault (fault liability) comes into play. In that case, in relation to an unqualified
provider of trust services, it is rules on liability based on fault in which fault must be proven (the
criterion of proven guilt). The burden of proof is on a natural or legal person claiming damages.
In relation to a qualified provider of trust services, it is rules on liability based on fault in which
the fault is presumptive. Since the provisions of The Regulation (EU) No 910/2014, in relation
to the assumptions of liability for damage, refers to national legislation, the rule in the Repub-
lic of Croatia is that the lowest degree of fault is presumptive, and it is the ordinary negligence.
(Klarić and Vedriš, 2006: 610).
17 That in national legislation is applying the rules on liability based on fault, it is clear from the
diction of article 9 of The Implementing Act of Regulation (EU) No. 910/2014., which, in relation to
the responsibilities of the signatory, ie. the natural person which generate the electronic signature,
in the use and storage of means and data for the generation of an electronic signature, requires
reasonable host diligence. (Implementing Act of Regulation (EU) No. 910/2014, 2017).
18 Thus, the Record of the Certification Service Provider in the Republic of Croatia, which is kept in
electronic form by the Ministry of Economy, Entrepreneurship and Crafts, determines the limitations
for transactions for which certifying service providers meet: up to 8000 kuna for standard security
certificates and up to 400,000 kuna for certificates high levels of security. One of certification service
provider has not limited the amount of transaction value it suits. (Ministry of Economy, 2013).
19 Therefore, the Agency for Commercial Activities Ltd., as one of the certification service provid-
ers, has published the Internal Rulebook on Certification Procedures of the Certification Body for
issuing certificates to persons for the purpose of electronic identity cards of the Republic of Croatia
(HRIDCA), Edition 2.0 from 7 July 2017, which states that the Agency for Commercial Activities Ltd.
has a insured risk of liability for damages arising from the provision of certification services in the
form of insurance policies, totaling of 2,000,000.00 kuna. The users of the service are informed in
advance from the web-portal about the terms of the certification services. (Agency for Commercial
Activities, 2017), hereinafter Internal Rulebook.

63
signatures, as well as misdemeanor provisions for qualified trust services pro-
viders aimed at the unauthorized use of an electronic signature (Implementing
Act of Regulation (EU) No. 910/2014 (18)), 2017).

4.3. The problem of unauthorized use of electronic signature

It is precisely the area of unauthorized use of advanced electronic signature
that is the biggest security problem that occurs in its application. Vulnerabilities
of users computer systems which using advanced electronic signature allow
unauthorized users access to a computer system and electronic signature cre-
ation tools that can lead to unauthorized creation of an electronic signature on
a user’s computer system or theft of a qualified certificate and related data,
including a decryption key (authorization code), and in some cases, unauthor-
ized use on other computer systems. Therefore, it is of utmost importance that
the users of the electronic signature their computing systems are kept safe,
including regular upgrades of the operating system, up-to-date antivirus and
antimalware protection, and to implement security measures that include phys-
ical and logical protection against access to the computer system and tools for
creating advanced electronic signature as well careful access to electronic con-
tent from unsafe sources, which may contain malicious software code that can
lead to compromise of the electronic signature creation system. By choosing
an advanced electronic signature issuer, users can also choose the technology
framework used for electronic signatures because within the records of the
certification service providers in the Republic of Croatia20, 21 there is a publicly
available list of norms which the service provider applies in his business.
In order to keep up with the technological development and maintain a suffi-
cient level of technological protection in the generation of advanced electronic
signatures, when is using the asymmetric cryptography system, PKI, the length
of the signatory key for the electronic signature creation must be at least 2048
bits. The use of cryptographic algorithms from the class RSA / DSA is also
required. National CA for the Republic of Croatia (NCARH) General Safety

20 For the compilation of the technical specifications necessary for the production of the products
and their placing on the market, in accordance with the current state of technology, are in charge
of standardization organizations. The ISO/IEC (International Organization for Standardization/In-
ternational Electrotechnical Commission) defines the general terms and principles of security of
information technology and defines a general model of assessment to be used as the the basis
for evaluating the security features of information technology products. The European Committee
for Standardization (CEN) has developed, as part of the European Commission’s standardization
requirements, the standards for qualified means for producing electronic signatures and making
electronic stamps. These standards are considered to comply with the requirements of Annex II of
The Regulation (EU) No 910/2014. (Commission Implementing Decision (EU) 2016/650 Introduc-
tory Statement (2-4), hereinafter Implementing Decision.
21 Article 1 paragraph 1 of Implementing Decisions stipulates that the standards for assessing the
safety of information technology products that are apply to the certification of qualifying means for
the generation of electronic signatures or qualifying means for the generation of electronic stamps
are set out in the Annex to the Implementing Decision. (Commission Implementing Decision (EU)
2016/650)

64
Regulations Version 1, dated 05/11/2013 (Ministry of Economy, 2013). de-
scribes the way in which the general rules of security are prepared, guided and
published. The general security rules relate to physical security, system access
control, operational security, backup and data archiving, operational personnel,
information confidentiality, and detailed documents relating to general security
policies, including: an information system security plan, physical security plan,
an incident recovery plan, software backup and data backup plan, and NCARH
operating manual, and they are related to policy of information confidentiality
and security policies22. The introduction of three-factor authentication, along
with the existing two-factor authentication to whom it belongs and the use of
advanced electronic signature, is one of the solutions to further increase secu-
rity in security issues created by unauthorized access to the computer system
of the user23.

4.4. Trust in the online environment

As stated in the introductory statement of The Regulation (EU) No 910/2014,
building trust in an online environment is key to economic and social develop-
ment. Due to the lack of confidence, especially because of the feeling of legal
insecurity, consumers, companies and public authorities hesitate to conduct
electronic transactions and use or introduce new services. Along with other EU
regulation24 The Regulation (EU) No 910/2014 represents the pertinence of the
payment industry in the EU. The European Commission held a series of meet-
ings of independent experts with representatives of financial services providers
and insurers’ representatives on issues of electronic payment in cross-border
finances and educating the public on the benefits of using electronic signatures.
It was expressed strong support for using smartphones and other mobile de-
vices to provide reliable use of electronic signatures (Woolfson and Terruso,
2015). In this respect, due to the speed of technological changes, The Regula-
tion (EU) No 910/2014 needs to adopt an open approach to innovations (Coun-
cil Regulation (EU), 910/2014, Introductory Statement (26)).
Despite the optimism that using of electronic signatures can have a signifi-
cant impact on e-finance, Cybercrime is a growing threat. It is emphasized that
mobile devices, in this sense, are particularly vulnerable. As more and more

22 National PKI Policy, Version 1.2 of 5 November 2013. determines that Security Policy is a stra-
tegic document and reflects the business needs of PKI protection. (Ministry of Economy, 2013).
23 In this regard, the Implementing Decision states that the preconditions for the security of certi-
fied products is the corresponding cryptographic algorithms, key lengths and summary functions, to
ensure that electronic signatures or stamps, which are generated by qualified means for making of
signatures or stamps are reliably protected from counterfeiting. Since this issue is not harmonized
at European level, Member States should cooperate on an agreement on cryptographic algorithms,
key lengths and summary functions in the field of electronic signatures and seals. (Commission
Implementing Decision (EU) 2016/650 Introductory Statement (8)).
24 Such as eg. Directive (EU) 2015/2366 of the European Parliament and of the Council of
25 November 2015, on payment services in the internal market, amending Directives 2002/65/
EC, 2009/110/EC and 2013/36/EU and Regulation (EU) No 1093/2010, and repealing Directive
2007/64/EC. (Council Directive (EU), 2015/2366).

65
people use their smart phones for finance, the number of incidents increases
considerably25. Commercial operators only become aware that the electron-
ic signature methods they use must be adequate, and that certain criminals
can even „break“ the two-degree authentication process. Professional users
and consumers needs continuous education to keep pace with the perpetrators
(Woolfson and Terruso, 2015). In this respect, in order to contribute to their
general cross-border use, it should be possible to use trust services as evi-
dence in court proceedings in all EU Member States (Council Regulation (EU),
910/2014, Introductory Statement (22)).

5. Conclusions
In the Republic of Croatia, electronic signature is subject to the regulation of a
special statute which regulate the implementation of European legislation on
electronic identification and trust services for electronic transactions. The use
of an electronic signature fulfills all segments of information technology in a
contemporary legal transactions through the authorization of electronic mail,
electronic documents and electronic contracts (Katulić, 2011: 1341). Although
more than 315 million Europeans use the Internet on a daily basis, less than
4% of online services are offered across national borders. For this reason, The
Regulation (EU) No 910/2014 has set a new legislative framework for electron-
ic identification and a new system of regulation and supervision for electronic
service providers in the EU, which should stimulate electronic commerce and
cross-border digital public services. This regulation places particular emphasis
on the recognition of means of electronic identification between Member States
for cross-border authentication, personal data security and application require-
ments for all providers of trust services and supervision of qualified service
providers. Building trust in an online environment is key to economic and social
development. Due to the lack of confidence, especially because of the feeling
of legal insecurity, consumers, companies and public authorities hesitate to
conduct electronic transactions and use or introduce new services. It is of the
utmost importance that the users of the electronic signature their computing
systems are kept safe, including regular upgrades of the operating system, up-
to-date antivirus and antimalware protection, and to implement security meas-
ures that include physical and logical protection against access to the computer
system and tools for creating advanced electronic signatures as well as careful
access to electronic content from insecure sources, which may contain ma-
licious software code that can compromise the electronic signature creation
system. In order to keep up with the technological development and maintain
a sufficient level of technological protection in the development of advanced
electronic signatures, in use of the asymmetric cryptography system, the length

25 Some types of services, such as Internet banking, use special devices, tokens, which ensure
the authentication of their users and their interactions with the banking system. The use of such
authentication devices, such as tokens, or biometric technology, is common in typical and specific
transactions of Internet banking. (Katulić, 2011: 1357).

66
of the signatory key to generate the electronic signature must be at least 2048
bits. The use of cryptographic algorithms from the class RSA/DSA is also re-
quired. The introduction of a three-factor authentication, along with the existing
two-factor authentication to which it belongs and use of advanced electronic
signature, is one of the solutions to further increase security in security issues
created by unauthorized access to the computer system of the user. The Reg-
ulation (EU) No 910/2014 predicts the responsibility of all providers of trust ser-
vices. It specifically establishes a system of responsibilities according to which
all providers of trust services should be liable for any damage to any natural
or legal person due to non-fulfillment of obligations under The Regulation (EU)
No 910/2014 which should be applied in accordance with national liability rules.
In this regard, we can conclude that electronic signature is the foundation of
electronic communications and commerce and it is legally identical to a hand-
written signature which must ensure the security of business communication
but remain easy to use to users.

67
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 CHAPTER 4

Sharing Economy and Workers’ Protection

Ana Pošćić,1 Sandra Laleta2

ABSTRACT

The creation of the single market in the European Union is a continuing commitment.
The European Commission published a series of documents in order to facilitate its
accomplishment. In the Single Market Strategy and the Digital Single Market Strategy
actions are focused on different levels. One of the targeted measures concerns creating
additional opportunities for consumers, professionals and businesses. The concept of a
balanced development of collaborative economy is particularly stressed. This concept
is also known as sharing economy, access economy or peer-to-peer economy. Sharing
economy business models present new opportunities to consumers, professionals and
workers in the areas that have been governed by traditional rules. The new model chal-
lenges the well-established procedures. Indeed, there are many open questions. This
article puts emphasis on the impact of sharing economy on the workers’ legal status and
workers’ protection, particularly on the category of crowdworkers.

Key words: Single Market, collaborative economy, sharing economy,

crowdsourcing, workers’ legal status

JEL classification: K31

1. Introduction
The creation of the single market in the European Union is a continuing com-
mitment. In order to facilitate its accomplishment, the European Commission
published a series of documents. It adopted the Single Market Act in 2011
with a series of measures to improve the European economy and create jobs,
while in 2012 it issued a communication, the so-called Single Market Act II
with a second set of priority actions. The main areas on which the Commis-
sion focuses are: “developing fully integrated networks in the Single Market,
fostering mobility of citizens and business across borders, supporting digital

* This paper has been supported in part by Croatian Science Foundation under the project “Flex-
icurity and New Forms of Employment (Challenges regarding Modernization of Croatian Labour
Law (UIP-2014-09-9377)“ and in part by the University of Rijeka project No. 13.08.1.2.03 “Social
security and market competition“.
1 Assistant Professor, University of Rijeka, Faculty of Law, Hahlić 6, 51 000 Rijeka, Croatia,
aposcic@pravri.hr
2 Associate Professor, University of Rijeka, Faculty of Law, Hahlić 6, 51 000 Rijeka, Croatia, san-
dra.laleta@pravri.hr

71
economy across Europe, strengthening social entrepreneurship, cohesion
and consumer confidence“ (Single Market Act II). The European Commission
presented a new Single Market Strategy in 2015 in order to complete these
goals. The main actions are dedicated to creating additional opportunities for
consumers, professionals and businesses, encouraging the modernization
and innovation that Europe needs and ensuring practical benefits for people
in their daily lives. According to our opinion, the first action deserves particu-
lar attention, and in this context especially the rapidly developing concept of
sharing economy. The model challenges the well-established procedures in
different sectors. This article puts emphasis on the impact of sharing economy
on workers’ protection, i.e. the employment status of crowdworkers and the
scope of application of employment legislation. At the outset it is necessary
to define the main concept.

2. Defining the concept of sharing economy

Sharing economy is far from unusual. People have benefited from sharing since
the onset of civilization. Albeit sharing has existed for centuries, the emergence
of digital technologies enabled more ways of collaboration. It is a new trend en-
abled by technology. Sharing economy may produce economic, environmental,
cultural and social advantages. The model is particularly widespread in certain
sectors such as transport, accommodation and professional services, however,
it is growing across the whole economy. It is also known as collaborative con-
sumption, sharing economy, peer-to-peer economy, access economy, demand
economy (Hatzopoulos and Roma, 2017: 84), gig or crowd economy. These
notions are used interchangeably. There is no uniform terminology or definition.
In a broader sense, sharing economy is considered to be a “part of a “collabora-
tive consumption” … trend, where sharing is viewed as a profitable alternative
to owning.” (Sprague, 2015: 3).
In his work “The zero marginal cost society” (2014) Jeremy Rifkin speaks of
sharing economy as the third industrial revolution.
There are few social, cultural and economic factors that have enabled the con-
cept of sharing economy to boost. One is certainly the technological evolution
that has made transactions easier and safer. The second refers to urbanization,
growth of population and the awareness of environmental issues, sustainability
and the need to focus on recycling. The last one refers to financial crisis and
the rise of unemployment (Hatzopoulos and Roma, 2017: 83). Changes in the
consumer behavior, social networks and electronic devices have pushed the
development of sharing economy.
According to a recent study, the five main collaborative economy sectors (peer-
to-peer finance, online staffing, peer-to-peer accommodation, car sharing and
music video streaming) have a potential to increase global revenues from
around EUR 15 billion now to EUR 335 billion by 2025 (What Do You Know
about the Peer-to-peer or Sharing Economy?, 2016).

72
It all started in the US in 1999 with the originally non-profit organization aiming
to match people who had an empty couch with people who wanted to travel
cheap (Couchsurfing). It inspired the creation of AirBnB and turned it into a big
business (Hatzopoulos and Roma, 2017: 84). The term was first used by Les-
sig who defined it as the “collaborative consumption made by the activities of
sharing, exchanging, and rental of resources without owning the goods” (Pus-
chmann and Alt, 2016: 95).
Collaborative economy according to the Commission “refers to business model
where activities are facilitated by collaborative platforms that create an open
marketplace for the temporary usage of goods or services often provided
by private individuals” (A European Agenda for the Collaborative Economy,
2016: 3). Three groups of individuals are involved: service providers, users
of those services and intermediaries that connect them (“the collaborative
platforms”).
Sharing has, of course, been around forever – and many industries offer al-
ternatives to ownership. As a model, according to the research of Pricewater-
houseCoopers LLP (2015), sharing economy is distinguished from other indus-
tries by these cornerstones: The first one concerns digital platforms as sharing
economy business models are hosted through digital platforms. The definition
of a platform depends on whether a platform only provides an information so-
ciety service or is offering other additional services. The second one concerns
the transaction costs connected with ownership. Everything is based on easier
and open access. Transactions using sharing business models implicate deep-
er social interactions. The last one is the so-called “a platform of experience”.
The value of the brand increases depending on social connections, conveni-
ence and confidence. The focus is more on trust then imbursement.
We can see that there are certain key elements: digital platforms, emphasis
on accessibility, peer-to-peer transactions, capitalizing of the unused capacity,
self-regulation (Hatzopoulos and Roma, 2017: 85), improvement of trust and
transparency and the creation of greater value. The collaborative economy has
many advantages. It can allow a more efficient use of resources and skills.
Some surveys indicate that participation levels in the collaborative economy are
already high in some sectors of the economy and have the potential to spread
even further. Current estimates indicate that 68% of adults globally are willing to
share or rent goods for money. (Global Consumers Embrace the Share Econo-
my, 2014). The sharing economy has, according to one estimate, the potential
to add EUR 160-572 billion to the EU economy (A European Agenda for the
Collaborative Economy, 2016: 2).
The importance of the collaborative economy has also been recognized in the
Digital Single Market Strategy for Europe (2015) in the context of the action on
platforms. It is necessary to assess the role of platforms in terms of transpar-
ency, data protection, relationship between platforms and suppliers, possible
obstacles on the movement from one platform to another and problems with the
unlawful content on the Internet.

73
Although sharing economy models offer many new ways of transactions com-
paring to traditional models, the well-established rules may not be suitable for
those models. The known legal frameworks often do not fit the new relation-
ships and models. Likewise, there could be problems with the applicable rules.
The Commission speaks of “complex ecosystems of on-demand services and
temporary use of assets based on exchanges via online platforms” (Upgrad-
ing the Single Market, 2015). According to the Commission there are a lot of
open questions. One of them concerns possible regulatory burden in form of
necessary business authorizations and registration obligations. The collabora-
tive platforms and service providers must have an open market access. Any
requirement for business authorization has to be justified, proportionate and
non-discriminatory. The next question is connected with uncertainty the con-
sumers are facing. Problems in relation to information asymmetry or a weaker
bargaining position may emerge in these transactions. Also, the distinction be-
tween business and consumers may sometimes be blurred, so we can ask who
in fact is the weaker party in need of protection. The next question reflects the
problems of liability as platforms take no responsibility other than to facilitate a
transaction between a provider and user. Sharing economy poses a number of
additional wider questions.
The collaborative platforms promote new employment opportunities. These im-
plicate the development of an on-demand economy and the impact this has
on workers. (Communication, 2015). It is a move towards flexible employment
relationships in comparison to regular traditional, standard employment rela-
tionships, based on a contract of employment for indefinite time, with full time
and usually from employer’s premises. The impact of digitalisation on work
organization, content of jobs, job opportunities and labour market in general
is a growing phenomenon, hence we speak of a “‘platformisation’ of labour”
(Houwerzijl, 2015: 1), or even “Uberification” (Wertz, 2015). ‘Platformisation’
of labour’ by virtual network organisations and ‘ICT-based mobile work’ that
takes place outside the employer’s premises are two manifestations of digital-
isation of work. They “cannot be fully separated from one another, but instead
represents a continuum, ranging from partially to fully digitalised work places
and employment relationships.” (Houwerzijl, 2015: 1). In following sections the
authors outline and analyse the most important issues concerning one of the
atypical forms of employment, namely crowd employment. A more in-depth dis-
cussion would go beyond the scope of this paper.

3. Crowdwork – notion and specificities

Crowdwork (crowdsourcing or crowd employment) is “an employment form
that uses an online platform to enable organisations or individuals to access
an indefinite and unknown group of other organisations or individuals to solve
specific problems or to provide specific services or products in exchange for
payment ... It is a new form of organizing the outsourcing of tasks, which would

74
normally be delegated to a single employee, to a large pool of ‘virtual work-
ers’.” (Eurofound, 2015: 207). The key element of this new form of employment
is a technology - online platform (an internet based ‘crowdsourcing platform’)
that enables a (generally) large group of prospective workers (the ‘crowd’) to
perform certain work, a task (subtask) or a service. The platform provides the
crowdworkers and supplies the infrastructure for tasks that have to be complet-
ed (Risak, 2016: 95). Therefore, it is defined as ‘a socio-technical work system
constituted through a set of relationships that connect organisations, individu-
als, technologies and work activities’. (Kittur, 2013: 109).
Crowdwork is interesting for companies as a way to engage a workforce po-
tential not available with other forms of work; to increase efficiency and save
costs; as an alternative to outsourcing and temporary agency work that are
also based on conventional employment relationships; as (frequent) involve-
ment of crowdworkers as freelancers that provide services independently
and with sole responsibility for the work result etc. (Risak, 2016: 95; Felstin-
er, 2011: 151ff). On the other hand, crowdwork is attractive for workers as a
way to reconcile work and family responsibilities, to provide extra money be-
sides other regular work, because of the freedom to choose the place, time and
the content of work, for learning opportunities, social exchange, the opportu-
nity for self-marketing etc. (Risak/Warter, 2015: 4; Klebe/Neugebauer, 2014;
Eurofound, 2015: 114).
Two types of crowdsourcing can be differentiated: internal and external. In case
of internal crowdsourcing “the crowd comprises a company’s internal work-
force”, and therefore usually poses fewer fundamental problems. In case of
external crowdsourcing, what is the topic of this paper, the employer (crowd-
sourcer) uses the crowdsourcing platforms that already have an active crowd.
The tasks that can be completed through the external crowdsourcing range
from very simple, repetitive activities (e.g. labelling and creating descriptions for
images, categorizing data and products, translating or proofreading short texts,
performing internet research etc.) that include low pay, highly standardised and
automated processes, to more complex, time-consuming tasks (testing soft-
ware products, designing products, writing programme code etc.) (Risak 2016:
94; Felstiner 2011: 148ff).
Further, two forms of work can be differentiated (European Parliament 2016: 1).
If the workers use a platform as a digital resource to perform the same work
or a service, it is a “virtual service”, that is transmitted via internet and can be
performed anywhere in the world (e.g. translation tasks or accounting). If a plat-
form mediates “physical services” (not digitalized work) that should be always
performed locally, e.g. plumbing, driving passengers or childcare, those servic-
es are “work on-demand via apps/internet” (Aloisi, 2016: 653ff). According to
De Stefano, despite the differences, both forms share some similarities: both
are enabled by IT and make use of the internet to match demand and supply
of work/services at an extremely high speed, the risk of dehumanization of
labour, possibility to shift risks and responsibilities to individual workers, the in-

75
security of income, the problem of lack of social security coverage (De Stefano,
2016: 473ff).
In comparison with standard employment, the crowd employment encompass-
es complex, multilateral contractual relationships. Due to its heterogeneity, it
is difficult to describe a unique or simple scenario and its actors. The man-
ner in which tasks are offered on the platforms (e.g. in a form of a competi-
tion between the crowdworkers), as well as the interests of the crowdwork-
ers (that could be divided on: those who have other sources of income; those
for whom the crowdwork is the only or the main source of income; those ex-
cluded from the labour market due to disabilities and social exclusion) vary
(Risak, 2016: 94-95).
In a very simplified scenario the ‘employer’ (user, client, buyer, crowdsourcer)
is a party for whom the crowdworker (seller, provider) performs work (task), or
provides services. These two parties usually do not enter into a direct contact,
but make contact through the platform. (Risak, 2016: 94). In general, the plat-
form acts as an intermediary or agent, without becoming directly involved in the
business between the employer (client) and a crowdworker. Their relationship
is, on the other side, often based on a bilateral agreement, rather than a formal
contract (Eurofound, 2015: 109). As the complexity of the crowdwork depends
on a platform set-up, further elaboration is needed (see infra 4).
Therefore, legal problems arising from crowdwork are the main topic of debate
of legal scholars. From the employment law point of view, most important are
the questions of the qualification of crowdworker (De Stefano, 2016: 471ff; Bje-
linski Radić, 2017: 888) - which is most discussed - as well as the identification
of the responsible employer who would enable the allocation of rights and re-
sponsibilities (Prassl/Risak, 2016: 619ff).
It must be emphasised that from the very beginning one of the most burning
issues among many controversies about ‘sharing economy’ concerns the dis-
pute over eroding labour security and inequalities (Codagnone/Martens, 2016:
17). The research carried out by Eurofound has found that, on one side, even
though the crowd employment platforms were regulated by the general legal
framework (commercial and civil codes, consumer protection acts and data
protection legislation), there was no evidence that “any legal or collectively
agreed framework specifically addressing crowd employment in Europe” exists.
On the other side, the research has shown that crowdworkers perform work as
self-employed, whereas economic independence is assumed. Consequently,
labour law regulation does not apply, and crowd workers are not entitled to
a minimum wage, paid annual leave or a compensation of wage in case of
sickness (Eurofound, 2015: p 109). In general, the pay, working conditions and
other issues (e.g. intellectual property rights) are determined either by the in-
dividual agreement of the client and worker, as the contracting parties, or the
terms and conditions of the platform (Klebe/Neugebauer, 2014: p 5ff). The ILO
concluded that “the platforms are not regulated by governments but … rather,
the platforms regulate the market” (Berg 2016: 18).

76
4. The legal status of crowdworkers – Self-employed or workers?
One can agree with the widespread opinion that crowdsourcing is “the biggest
paradigm shift in innovation since the Industrial Revolution” (Kaufman, 2008).
In comparison with the standard employment relationship, crowdworkers per-
form work in a cyberspace workplace, often anonymously, with no physical job
site. “Crowd work is characterized by many-to-many connections, with some
connections lasting as little as a minute or two.” (Felstiner, 2011: 145-146) The
platforms see themselves as digital agents, that connect customers and inde-
pendent contractors, and their terms and conditions vary from country to coun-
try, always pursuing identical aims – the denial of worker status. On the other
hand, the platforms exercise significant control, from setting wages to specify-
ing and supervising how the work should be done (Prassl/Risak, 2016: 619).
Crowdwork seems to challenge the boundaries of labour and social protec-
tion and of employment relationship (De Stefano, 2016(a): 463). It has brought
about the problem of determining the scope of labour law legislation (employ-
ee-protective) norms: are crowdworkers workers deserving of labour law pro-
tection, or self-employed, independent contractors, or a genuinely novel form
of work that deserves its own legal status and regulatory apparatus? (Prassl/
Risak, 2016: 619ff).
“All systems of labour law draw a fundamental distinction between employ-
ment which is categorised as ‘dependent’ or ‘subordinate’ and that which is
‘independent’ or ‘autonomous’. (Deakin/Morriss, 2012: 145). In most legal sys-
tems protective labour law provisions apply to workers (employees), persons
that perform work personally, for a remuneration, in a relationship of personal
subordination to the employer. The persons who work as independent con-
tractors are usually not covered by those protective provisions. The distinction
between self-employed and subordinate workers, a cornerstone of labour law,
has raised difficult questions and has remained largely undefined. Various tests
have been developed in civil and common law jurisdictions in order to make dis-
tinction between the self-employed worker and the employee. (Engels, 2014:
361-373). Those tests “refer to a host of factual circumstances on the basis
of which decisions are being taken to label a given work contract either as an
employment contract or as a contract for the independent delivery of services.
None of the characteristics or facts seem to be determinative themselves.” (En-
gels, 2014: 371).
Under the ‘actual control test’, one of the early tests, it is required that the em-
ployer, the entity, legal or natural person, actually controls (either personally or
through the intervention of supervisors) the work performed by the worker. As
this test became inadequate to protect workers who have skills that make them
independent of the business enterprise, the courts developed the test of the
employer’s ability to exercise control. Afterwards, the economic dependency
test was developed, in which the judges look at the existence of the economic
dependence, i.e. the fact that the worker is dependent on his/her income from

77
work to survive. The most used is a hybrid (mixed technique test) test, in which
judges apply all the previously mentioned tests (Engels, 2014: 371-373).
The important instrument in this field is the ILO Employment Relationship Rec-
ommendation No. 198 (2006) which invites the ILO Member States to formulate
and apply a national policy for reviewing and, if necessary, clarifying and adapt-
ing the scope of labour laws and regulations in order to guarantee effective
protection for workers in an employment relationship. Members may consider
clearly defining the conditions applied for determining the existence of an em-
ployment relationship. In this document subordination or dependence is given
as an example. It should be emphasised that this criterion is one of the crucial
ones used in practice in determining the existence of employment relationship.
The Recommendation also enumerates a number of specific indicators for de-
termining the existence of the employment relationship, e.g. “a) the fact that
the work is: carried out according to the instructions and under the control of
another party; involves the integration of the worker in the organization of the
enterprise; is performed solely or mainly for the benefit of another person; must
be carried out personally by the worker; is carried out within specific working
hours or at a workplace specified or agreed by the party requesting the work;
is of a particular duration and has a certain continuity; requires the worker’s
availability; or involves the provision of tools, materials and machinery by the
party requesting the work; (b) periodic payment of remuneration to the worker;
the fact that such remuneration constitutes the worker’s sole or principal source
of income; provision of payment in kind, such as food, lodging or transport;
recognition of entitlements such as weekly rest and annual holidays; payment
by the party requesting the work for travel undertaken by the worker in order to
carry out the work; or absence of financial risk for the worker.” (section II.13).
According to the principle of ‘primacy of facts’, recalled in the Recommenda-
tion, “the determination of the existence of an employment relationship should
be guided primarily by the facts relating to the performance of work and the
remuneration of the worker, notwithstanding how the relationship is character-
ized in any contrary arrangement, contractual or otherwise, that may have been
agreed between the parties”. Consequently, the judge has to take into consid-
eration all the relevant facts and the circumstances of the case, giving primacy
to the reality of the facts over the legal qualification of the contractual parties
(Grgurev, 2017; Senčur Peček/Laleta, 2018).
Searching for the answer about the legal status of crowdworkers, one of the
approaches is the analysis of different types of contractual relationships associ-
ated with the typical crowdsourcing set-ups (Risak, 2016: 96ff; Felstiner, 2011:
168ff). If the crowdsourcing platform acts solely as a broker (agent), a direct
contractual relationship exists between the crowdworker and the crowdsourcer
(client). It is generally a contract for services. Its content is largely determined
by the standard contractual forms and terms and conditions provided by the
crowdsourcing platform. As the platform has strong influence on these rela-
tionships, it can be argued that in reality it is “a covert contractual relationship
between the crowdworker and the platform.” (Risak, 2016: 97).

78
If the crowdworkers are registered with the platform and the task is taken
on, the general terms and conditions of the platform apply. Placement of the
task on the platform represents an offer to the crowd or may be considered
only an offer to the crowd to make an offer. The contract is concluded when
the task completed by the worker is accepted by the platform. Both contract
partners shall have the right to reject services. This contract can be classi-
fied as a contract of employment or a contract for services, depending on the
intensity of the influence the contractual partner has on the work performed
(Risak, 2016: 97-98).
If the platform serves as intermediary (providing infrastructure) between the
crowdworker and the crowdsourcer, this represents “a placement service”, for
which only the crowdsourcer pays. It does not represent temporary agency
work due to the lack of integration of the worker in the crowdsourcer’s busi-
ness, and of managerial prerogative and control by the crowdsourcer. (Risak,
2016: 98).
When the crowdworker performs work for the platform, it is deemed to consti-
tute an employment relationship if the work is done in a relationship of person-
al dependency. The worker should be “integrated into an external operational
body and be subject to the right to instructions on the part of the recipient of the
service” (Risak, 2016: 98). Even though the contractual relationship is often of
a very short duration and the performance takes place at a separate location
over the internet, according to Risak, it “is important whether this takes place in
a kind of ‘virtual workshop’, i.e., using an interface provided by the crowdsourc-
ing platform, and whether it involves monitoring mechanisms” (Risak, 2016: 98,
99). Also important are opportunities for disciplining the crowdworker through
ratings on platforms (Risak, 2016: 99; Bjelinski Radić, 2017: 895ff), and deter-
mination of work-related behaviour (e.g. through the specification of allotted
time), that “equals ‘classical’ personal dependency necessary for an employ-
ment relationship” (Risak, 2016: 99). A specificity of crowdwork is the often ex-
tremely short duration of the contractual relationship (the task often takes some
minutes), but this can be compensated by a high level of external control (e.g.
regular screenshots or automated analysis of the workflow) (Risak, 2016: 99).
We can conclude that a spectrum of different indicators should be used in order
to determine the existence of the employment relationship.
In literature a different approach to legal problems arising from crowdwork can
be found that adopts a functional concept of employer that analyses which par-
ty, if any, in the multilateral contractual relationships that characterize this type
of work can be identified as responsible employer. The main functions and their
functional underpinnings of the employer are: inception and termination of the
employment relationship; receiving labour and its fruits; providing work and pay;
managing the enterprise – internal market, managing the enterprise – external
market. “It is the ensemble of the five functions that matters: each of them cov-
ers one of the facets necessary to create, maintain, and commercially exploit
employment relationships, thus coming together to make up the received legal

79
concept of employing workers or acting as an employer – and being subjected
to the appropriate range of employee-protective norms.” (Prassl/Risak, 2016:
620, 636). On the other side, Sprague argues in favour of “the classification test
that focuses not on the dependence of the workers on the employer, but the
dependence of the employer on the workers. If the enterprise arranging all of
these individualized tasks and services is dependent on the service providers
for its existence, then those service providers should be considered employees
of the enterprise.” (Sprague, 2015: 23).

5. Working conditions
In general, the working conditions of the crowdworkers seems to be poor, in-
cluding low and insecure remuneration, legal insecurities, job insecurity, poten-
tially unfair terms and conditions of work etc. (Risak/Warter, 2015: 3).
Eurofound’s survey research has found that the pay of crowdworkers is ex-
tremely low. For example, 25 % of the tasks offered at Amazon Mechanical
Turk are valued at $0.01, 70% offer $0.05 or less, and 90% pay less than $0.10,
what is equal to an hourly rate of around $2. Czech Topdesigner.cz offers tasks
that are small in scale, with an average pay of $200, while the worker who per-
forms work for German Clickworker can earn $200 – 400 per month, for about
30 hours of work. (Eurofound, 2015: 115). For comparison, it seems that the
workers that provide physical/local services (‘work on-demand’) earn more per
hour than the workers – suppliers of virtual services, and high-skilled workers
more than low-to-medium skilled workers (European Parliament, 2016: 9). Fur-
thermore, there is insecurity whether work, that is not continuous or regular,
will always be paid (Eurofound, 2015: 115; Felstiner, 2011: 167). Consequently,
crowdwork is often precarious work (Bodiroga-Vukobrat et al., 2016).
As self-employed, crowdworkers lack representation. Other negative aspects
include the possibility of privacy violation and the lack of support from col-
leagues and managers (Eurofound, 2015: 115). According to OSHA, platform
work has an impact on health and safety of workers, because they are exposed
to psychosocial risks that are still unknown and in need of further investigation
(OSHA, 2015: 2).
In 2016 the platforms in Europe had around 100,000 active workers (represent-
ing 0.05 % of total employees in the EU). (De Groen/Maselli, 2016: I). Devel-
opment of crowdwork in Croatia is marginal. The most known platform is Uber.
An individual can perform work as the driver-partner, a self-employed person
(craftsman or a simple private limited liability company), but also as the em-
ployee of rent-a-car businesses that perform work for Uber. Uber Croatia d.o.o.
(LLC), registered in Zagreb, in 2016 had an income of 4.2 million kunas (around
564.000 €) and a profit of 232.700 kunas (around 31.234 €) (Jutarnji list, 2018).
Several platforms offer job performance. In addition, there are several applica-
tions for students’ employment (e.g. ‘yourJob’, Danasradim.hr), the platform for
youth employment Get Ready 4 Work etc.

80
It must be emphasised that platform work does not attract persons who are un-
employed or inactive, but the under-employed or the self-employed, wishing to
work more, and unable to find full-time employment. Two studies suggest that
the individuals from the socially most excluded groups are neither aware of the
digital labour possibilities, nor have the necessary skills to participate in them
(European Parliament, 2016: 8).

6. Conclusion
The emergence of crowdwork in Europe is a relatively recent phenomenon with
permanent growth, not only because of the economic and financial crisis, but
also due to the modern technologies that offer opportunities especially in light
of the need to reconcile private and work life and for those looking for alterna-
tive forms of employment (Eurofound, 2015: 111).
The legal employment status of crowdworkers is the central issue of the schol-
arly debates and research studies which advocate different approaches. Ac-
cording to the authors of this article, the crucial issue is to determine whether
the crowdworker performs this type of work as self-employed or as a worker in
a relationship of personal subordination or dependence. The well-known spec-
trum of indicators or tests should be used in order to determine the existence of
the employment relationship. The most recent decision of the Court of Justice
of the EU in the case Uber (Case C-434/15 Asociación Profesional Elite Taxi v
Uber Systems Spain SL) will have the implications on the legal status of work-
ers. For the sake of the protection of the army of people engaging in crowd-
work every day, the question is “how do we ensure that workers have access
to decent labour and social protection whilst engaging in platform work.” (De
Stefano, 2016(a): 462). These forms of employment are a necessary element
of modern labour markets, but as they pose an inherent danger to the working
conditions and the labour market they should be addressed through legislation
and regulation (Eurofound, 2015: 144).
In the wider context of sharing economy in general, the dilemma is of regu-
lation versus innovation. While some minimum rules are needed, too much
regulation could stifle innovation (Hatzopoulos/Roma, 2017: 126). We are more
in favour of innovation. Sharing is not a novel concept, but with digital tools it
has been given completely new potentials. This model has disrupted all sec-
tors and has changed the way we work. It is necessary to understand the new
definitions in order to be able to detect possible problems and offer clarification
and possible solution. The concept of sharing economy allows occasions for in-
creased efficiency, growth and jobs, however, it also increases regulatory prob-
lems (A Digital Market Strategy for Europe, 2015: 7), calling for the adoption of
a balanced solution.
To date, there has been no regulation of this model in the EU. The EU opted for
a fragmentary approach. Most of the older legal concepts are not well adapted

81
to sharing economy. We should not overregulate it, but, on the other hand,
certain minimum rules are necessary. The question is should we regulate it at
all or maintain the current state and see what happens. This can be seen in
the transportation sector. There are legal battles concerning safety conditions,
unfair competition and particular labour law issues.

82
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86
Appendix

Skills Definition in Digital Competence Framework

Information Identify, locate, retrieve, store, organise and analyse digital
skills information, judging its relevance and purpose.
Communicate in digital environments, share resources through
Communication online tools, link with others and collaborate through digital
skills tools, interact with and participate in communities and networks,
cross-cultural awareness.
Identify digital needs and resources, make informed decisions
as to which are the most appropriate digital tools according to
Problem
the purpose or need, solve conceptual problems through digital
solving skills
means, creatively use technologies, solve technical problems,
update one’s own and others’ competences.
Create and edit new content (from word processing to images
and video); integrate and re-elaborate previous knowledge and
Software skills content; produce creative expressions, media outputs and pro-
gramming; deal with and apply intellectual property rights
and licences

Table A1. Skills in Digital Competence Framework

Kaiser-Meyer-Olkin Measure of Sampling Adequacy. .822

Approx. Chi-Square 357.373
Bartlett’s Test of Sphericity df 36
Sig. .000

Table A2. KMO and Bartlett’s test

87
 PART 2

INDUSTRY 4.0 AND BEYOND

DIGITAL SINGLE MARKET IN EUROPE / SOCIAL AND
LABOUR MARKET ISSUES IN DIGITAL WORLD
 CHAPTER 5

Selecting location for a new business unit in ICT industry

Sanja Marinkovic1, Ilija Nikolic2, Jovana Rakicevic3

ABSTRACT

Location theory is studying how location is impacting any economic activity, trying to an-
swer where operations should settle and what is the reasoning behind such decisions.
The aim of this paper is to discuss and prioritize the key location determinants for suc-
cessful selection of an optimal location in ICT industry and to emphasize the importance
of this concept in ICT sector, given the trends and changes global economy is facing,
specially today with digitalization and big internet revolution. The initial determinants
were formed based on the literature review and evaluated through two round Delphi
study among experts from ICT companies in Serbia. The second goal of the study was
to reach consensus about relative importance between agreed determinants. According
to the obtained results using AHP decision making model, the first priority in location
selection in ICT industry is human resource availability, second priority should be placed
on the political and economic environment and the third priority should be placed on
the competition. It can be concluded that political and economic strategies are starting
to play a bigger role in ICT market, as governments are getting more interested in this
industry. The study confirmed that due to a shortage of supply and fierce competition in
the ICT sector, the concept of location selection is an important success factor for sus-
tainable growth and development of ICT organizations.

Key words: Location determinants, Delphi study, AHP decision-making,

ICT industry

JEL classification: D70, L21, M15, M21, R39

* This paper is published in Proceedings of Rijeka Faculty of Economics-Journal of Economics

and Business/Zbornik Ekonomskog fakulteta u Rijeci: časopis za ekonomsku teoriju i praksu, Vol.
36, No.2, pp. 801-825, DOI: https://doi.org/https://doi.org/10.18045/zbefri.2018.2.801
1 Associate Professor, University of Belgrade, Faculty of organizational sciences, Jove Ilica 154,
11000 Belgrade, Serbia. Scientific affiliation: technology management, innovation management,
operations management. Phone: +381698893176. E-mail: marinkovic.sanja@fon.bg.ac.rs
2 Master student, University of Belgrade, Faculty of organizational sciences, Jove Ilica 154, 11000
Belgrade, Serbia. Scientific affiliation: ICT management, international management. E-mail: ili-
ja89.n@gmail.com
3 Teaching Assistant, University of Belgrade, Faculty of organizational sciences, Jove Ilica 154,
11000 Belgrade, Serbia. Scientific affiliation: technology management, technology entrepreneur-
ship. Phone: +381698893562. E-mail: jovana.rakicevic@fon.bg.ac.rs

91
1. Introduction
In predicting a long-term survival and growth, location has always played a vital
role. Due to shortage of supply and fierce competition in the ICT sector, over
recent years the concept of location selection has been recognized as a key
success factor for sustainable growth and development of ICT organizations.
ICT sector serves as an intermediary between customers, and MNCs enabling
a company to establish an online presence and global reach. Staying competi-
tive in today’s terms means that services should be available to customers in a
few clicks, being capable to process huge amount of data in real time for accu-
rate decision making. Also, it implies having backend systems that can manage
effectively the production, inventory or other areas of business.
Location theories are studying how geographic location is impacting any eco-
nomic activity. The main question that this theory tries to answer is where
should economic activity settle and what is the reasoning behind such deci-
sion. Given the internet and true integration and collaboration on global level
it is interesting to discuss if location in this sense has still equal importance in
the ICT industry as before the big “WWW” revolution. The aim of this paper is
to discuss and prioritize the key determinants for successful selection of an op-
timal location in the ICT industry and to emphasize the importance of this con-
cept in the ICT sector given the trends and changes global economy is facing,
particularly ICT sector.

2. Literature review
The sector of Information and Communication Technologies (ICT) is one of the
key instruments for the development of an economy (Muñiz & Cuervo, 2014).
As a consequence of such growth, the competition on this market became
fierce. The rapid growth in total employment of specialists in this area confirms
the increasing importance of ICT in the global economy (European Commis-
sion, 2017). Providing the services of best quality while keeping the costs in
control is the formula for success. As an appealing solution for the manage-
ment of ICT companies the outsourcing strategy is often chosen. In this setup
companies retain only their most experienced engineers and managers, while
all the other responsibilities are given away to the supplier, usually coming from
a less developed country where costs are typically lower than in the home
country of the company.
However, with this trend, another challenge emerged where the demand for
highly capable software engineers is now larger than the general supply on the
markets. Hence, for outsourcing companies to grow, they have to choose an
optimal location, where the long-term success and stability is possible. Compa-
ny location can be defined as a geographical and central place for the company
to realizeit’s all basic occupations and to carry on relations with its close and
far environs (Burdurlu & Ejder, 2003). Location choice is a strategic decision

92
which has an influence on revenue and costs also, and the main question for
starting a business is where to locate a facility, particularly in this age of global
markets and global production (Gusavac, Stojanovic, & Kuzmanovic, 2013).
’The location theory of business locations applies explicitly to the choice of the
location to establish a business’ (Noort & Reijmer, 1999). The developmentof
teheories in this field recognized the following: 1. (Neo) Classical location theo-
ries: Land use, Industrial Location (Weber and Isard), Central Places (Christall-
er andLösch), Spatial Competition (Hotelling); 2. Behavioral location theory;
3. Institutional Approach, 4. Agglomeration Theory (alaMichael Porter Cluster
Theory). In general, within economic geography, neo-classical, behavioral, and
institutional location theories are used to explain firm migration (Pen, 1999).
ICT sector serves as an intermediary between customers and MNCs ena-
bling a company to establish an online presence and global reach. Staying
competitive in today’s terms means that their services should be available to
customers in few clicks, being capable to process a huge amount of data in
real time for accurate decision making, and having backend systems that can
manage effectively the production, inventory or other areas of a business. The
service sector is now a major component of the global economy, particularly
in the majority of developed countries. Because of its advantageous capabili-
ties to dramatically accelerate communication speed and increase information
channels, ICT saves costs while increasing the output and quality of most ser-
vice productions. Since the ICT is becoming ever-so-important in the service
industry, it is common that every such company has an ICT department of
their own. To further cut the costs, companies are also turning to outsourcing
as a business strategy.
IT outsourcing, defined as the process of commissioning part or all of an or-
ganization’s IT assets, people, and/or activities to one or more external service
providers, has emerged as a viable option in information systems manage-
ment (Lee, 2006) There is still an ongoing debate in business management
world whether outsourcing is a successful strategy, and if it is applicable for
any business case. Primary motivators for such strategies are also changing.
Furthermore, as the motivations of outsourcing are increasingly evolving from
cost reduction to business performance improvement, it is crucial for organiza-
tions to align their outsourcing strategy with their business strategy (Lee, 2006).
However, according to another paper, “many business organizations often treat
outsourcing as de facto solution, based on assumption, that savings will be
achieved without in-depth analysis of the real strategic and economic factors
and values” (Boguslauskas & Kvedaravičienė, 2015).
Even today outsourcing as a strategy is a debatable topic among business pro-
fessionals. It is also mentioned in the journal article as “very topical issue” (An-
done & Pavaloaia, 2010, p. 164). While it can be very successful, outsourcing
can prove to a be very difficult challenge to achieve. Majority of reasons may be
connected with the way a company decided to opt for a strategy of outsourcing.

93
“A survey conducted by KPMG International shows that 42% of outsourcing
agreements are based on a formal framework designated for benefits assess-
ment at the strategic level of the enterprise.

2.1. Location selection factors in ICT context

To identify factors or criteria for location choice it should start from product or
service characteristics and business sector (Stojanovic, 2005). In the case of
this paper, the main interest is put on ICT industry. This industry, depending on
a segment, can be categorized as the production as well as a service industry.
Further, within the production segment, ICT companies may be involved in pro-
duction of for end-users (e.g., personal computers) or their core business may
involve production of certain high technology parts (e.g. computer processors).
On the service end of the spectrum, ICT companies may further differentiate
based on for whom they provide the services, end customers or to intermedi-
ates. In case of outsourcing companies, as analyzed in the previous section,
services are not being offered directly to the customers. Rather, the company
which is outsourcer is providing the value for end-customers. Based on this
differentiation factors for location selection in the ICT context may differ. In the
table below general factors for business location selection are presented.

Major factors Sub-factors

Fixed costs; transportation costs; wage rates and trends in
wages; energy costs; other manufacturing costs; land cost; con-
Costs
struction/leasing costs and other factors (e.g. R&D costs, trans-
action and management costs etc.)
Quality of labor force; availability of labor force; unemployment
Labor
rate; labor unions; attitudes towards work and labor turnover;
characteristics
motivation of workers and workforce management
Existence of modes of transportation (airports, railroads, roads
and sea ports); quality and reliability of modes of transportation;
Infrastructure
quality and reliability of utilities (e.g., water supply, waste treat-
ment, power supply, etc.) and telecommunication systems
Quality of suppliers; alternative suppliers; competition for sup-
Proximity to
pliers; nature of supply process (reliability of the system) and
suppliers
speed and responsiveness of suppliers
Proximity Proximity to demand; size of market that can be served/poten-
to markets/ tial customer expenditure; responsiveness and delivery time to
customers markets; population trends and nature and variance of demand
Proximity to
parent company’s Close to parent company
facilities

94
 Major factors Sub-factors
Proximity to
Location of competitors
competition
Quality of environment; community attitudes towards business
and industry; climate, schools, churches, hospitals, recreational
Quality of life
opportunities (for staff and children); education system; crime
rate and standard of living
Compensation laws; insurance laws; environmental regulations;
Legal and industrial relations laws; legal system; bureaucratic red tape;
regulatory requirements for setting up local corporations; regulations con-
framework cerning joint ventures and mergers and regulations on transfer
of earnings out of country rate
Tax structure and tax incentives; financial incentives; customs
duties; tariffs; inflation; strength of currency against US dollar;
Economic factors
business climate; country’s debt; interest rates/exchange con-
trols and GDP/GNP growth, income per capita
Record of government stability; government structure; consis-
Government and
tency of government policy; and attitude of government to in-
political factors
ward investment
Social and Different norms and customs; culture; language and customer
cultural factors characteristics
Availability of space for future expansion; attitude of local com-
Characteristics munity to a location; physical conditions (e.g., weather, close to
of a specific other businesses, parking, appearance, accessibility by custom-
location ers, etc.); proximity to raw materials/resources; quality of raw
materials/resources and location of suppliers

Table 1. Summary of major factors and sub-factors affecting international location

decision (adapted from Gusavac, Stojanovic, & Kuzmanovic, 2013)

Given that one of the main reasons for opting for outsourcing strategy is cost
reduction, costs as a location factor may have a critical role. ICT is a knowledge
intensive industry, where the success of company usually relies on how capa-
ble the workforce is. Therefore, labor characteristics should play a significant
part in the decision. Infrastructure factors may also play important part since
ICT companies (especially the outsourcing ones) depend on reliable infrastruc-
ture when it comes to transportation and telecommunication systems. Similarly,
it can be seen that for outsourcing company most of the factors and sub-factors
are relevant.

95
3. Research methodology
Introducing the problem of location selection in the ICT industry implies the un-
derstanding of contributing determinants to such decision. The initial determi-
nants were formed based on the literature review and conducted Delphi study
among experts from ICT companies in Serbia. The study was designed to offer
initial determinants for the defined problem leaving the option to the experts to
extend the initial list or agree to the same. The conclusion was that consensus
was reached around same determinants as originally proposed. The second
goal of the study was to reach consensus about relative importance between
agreed determinants. The initial determinants were defined based on litera-
ture review and analysis. Figure presents the starting point, from which it was
deduced which determinants should be included in the model. In the study,
they were grouped in three principal areas: quantitative, qualitative and other.
Twelve determinants for choosing an optimal location for opening a new busi-
ness unit in ICT industry are capital investment costs, transportation costs and
operation costs from quantitative perspective, political and economic environ-
ment, legal framework, competition, and suppliers from qualitative perspective,
and human resources availability, infrastructure availability, and cultural com-
patibility in the last group.

Figure 1. Research framework for location evaluation in ICT industry

96
MNC’s commonly capitalize on foreign business opportunities by engaging in
foreign direct investment (FDI), which is investment in real assets (such as
land, buildings, or even existing plants) in foreign countries (Madura & Fox,
2011) The costs generated as a direct result of FDIs are capital investment
costs. Since in the ICT industry the trend of outsourcing is evident, and was
ellaborated more in the previous chapter, this determinant should be analyzed
with foreign perspective emphasized. Though, the same costs apply when the
company is investing localy.
It is also important to understand that capital investment costs can be influ-
enced by other factors like economic and political circumstances of the par-
ticular market. For example, costs may be lower due to subventions programe
the goverment defined to encourage foreign investments into local ICT sec-
tor. Another example would be the progressive tax policy where the initial in-
vestment may look appealing to the investor, but after more thorough eval-
uation it could turn out that projected benefits are not compesating the real
costs. Most consumption requires either the conveyance of finished goods or
the transfer of people to the points at which goods and services are supplied
(Stephen J. Redding, 2014).
The conveyance of goods in ICT sector has a different meaning, though, since
the final product of the ICT industry is located in virtual space and can be trans-
fered via internet. Similar analogy could be made for raw materials and fuel,
since the only inputs ICT really needs is electricity and internet connection.
These costs are influental, but should be analyzed as part of operational costs.
However, since ICT is primarily a service industry, distance between delivery
centers and customers may impact the costs. Further, the location of the com-
pany relative to the labor may also result in higher transportation costs on reg-
ular basis in order to enable employees to deliver final products or services.
According to the Corporate survey from 2009 it was concluded that the labor
costs is the single most important factor in site selection decision. Increasing
consumer demand for lower-priced products is driving companies to find ways
to lower manufacturing costs. Companies have been forced to look at ways
to control and reduce operating costs such as labor costs, inbound/outbound
shipping costs, utility costs, corporate tax rates, occupancy costs, and other
factors - most of which were also listed as top-10 factors in the Area Develop-
ment Corporate survey (Michelle Comerford, 2017).
Similar trend is found in the ICT industry, where labor costs are the most sig-
nificant part of operational costs. In order to reduce their costs ICT companies
from US or Western Europe are rellocating their development centers towards
countries with cheaper labor force. The demand is significantly higher than the
supply on the ICT labor market. Therefore,the employees from ICT compa-
nies are used to extra benefits not usually found among companies from other
sectors such as flexible working hours, working from home policies, benefits
packages etc. Since there is not enough ICT professionals available on the

97
labor market, companies are investing extrain effort in order to attain and retain
talents. This is also a determinant in operational costs which could impact the
decision for choosing an optimal location. Other significant operation costs for
an ICT company is related to the infrastructure and software required for de-
velopment. However, compared to the labor costs, those are less significant.
When considering the political factors, a company needs to evaluate the amount
of influence a government has on the economy. Those factors may include tax
policy, trade restrictions, and tarrifs, etc. On the other hand, country stability and
risks related to country risks (such as hostile takeovers, wars, sanctions, etc.)
need also be taken into account. Every country also has a strategy of growth.
This strategy may involve the production of some products or services to be
demerited, while others to be supported by subventions, government loans or
other means. In general, measures of fiscal policies may also be considered as
part of political environment.
On the other hand, the economic factors are more quantitive indicators of the
market and can be viewed as a quantitie prospect of a country. These may
include growth of GDP, and the three main economic indicators, the interest
rates, exchange rates, and the inflation rate. These factors can influence great-
ly how the busness operate in specific markets.
In the case of ICT industry we can see that the importance is recognized by
all conuntries of the world in various extent. This is expecially the case for the
developing countries as supported by the analysis of the European Parlament:
While the legal framework is also impacted by the government and is consisted
of several different elements, the political and economic factors are oriented on
the government from the perspective of foreign trade policies and fiscal poli-
cies. Legal elements may include employement regulations, competitive regu-
lations, health and safety regulations, product regulations, antitrust laws, patent
infringements etc. Respecting those regulations is even more complex in case
of multinational corporations which are doing businesses in different conutries,
even different continents.
Company that has a similar target group in the same industry with similar prod-
ucts can be considered as a competitor. Factors which are influencing the level
of competitveness can be extracted. Those may include, but not limited to, cost
of production, price of final products, marketing activities, customer loyalty, and
access to technology.
In Porter’s Five Forces model special attention is given to the suppliers. They
are companies that supply raw materials, equipment, machinery, associated
services and labor (Indiatsy, et al, 2014). In the Porter’s model the barganing
power of suppliers is seen as a force that may impact the competiteveness of a
company. Suppliers can influence company’s price, quality, and overall delivery.
An ICT industry is an industry which is very dependent on highly educated
human resources. In process of creating software, rather than using raw mate-
rials and production facilities, everything is happening in the mind of software

98
engineers which is then transfered to an executable code. There is a trend in
the world of shortage for softare engineers. Therefore human resources are
becoming a bottleneck in meeting the market demand for software products.
In the published paper key human resource challenges in one of the greatest
centers of software industry, India, are ellaborated and studied. Those include
managing human resources in a globally distributed team, shortage of soft-
ware professionals having sufficient knowledge and competencies, low-skilled
nature of the work, lack of well-developed HR systems and processes, high
employee turnover, lack of work-life balance, and the problems associated with
the use of contract employees (Agrawala, Khatrib, & Srinivasanc, 2012).
Infrastructure availability as a factor contributing to location related decisions
was analyzed by Kazuo Kadokawa in his paper from 2011. In his paper he is
mentioning „infrastructure-related reasons“. He names the reasons„as com-
muting convenience, industrial zoning, unrestricted environment, access to
highway and business and logistic services.“ (Kadokawa, 2011) Though
Kadokawa was exploring the infrastructure factors for the placement of a plant
for producing goods, these factors may apply to the ICT industry. For the ICT
sector, specificaly access to stable and high speed internet, provided by the
internet service providers may play a critical role.
The importance of world business has created a demand for managers sophis-
ticated in global management and skilled at working with people from conu-
tries other than their own (Adler & Gundersen, 2008). As mentioned, the ICT
industry is mostly relying on virtual communication, teams, products, and ser-
vices. Therefore, multicultural global teams are fairly common in the industry.
However, in order to achieve strategic goals, a company has to do a cultural
alignment among its business units. Culture consists of patterns, explicit and
implicit, of and for behavior acquired and transmitted by symbols, constituting
the distinctive achievement of human groups, including their embodiement in
artifacts; the essential core of culture consists of traditional ideas and especially
their attached values; culture systems may, on the one hand, be considered as
products of action, on the other, as conditioning elements of future action (Adler
& Gundersen, 2008). Therefore, when choosing the location for a new business
unit, local management and working culture needs to be taken into an account.

3.1. Methods used in data collecting

Two methods were used in this study in order to collect quantitative data: Delphi
and Analitical Hierarchy Process – AHP. Delphi method represents’a system-
atic procedure that collates the opinions of a diverse group of experts locat-
ed in different geographical areas whose opinions are important for decision
analyses. Through the Delphi technique, different responses and views are
obtained aon the underlying problem resulting in generating new ideas and
unique suggestions, and eventually provides consensus on the findings among
a panel of experts’ (Eskandari, et al., 2007). Another application is ranking-type
of problems. „Researchers have applied the Delphi method to a wide variety

99
of situations as a tool for expert problem solving. They have also developed
variations of the method tailored to specific problem types and outcome goals.
One variant that has received widespread use is the ’ranking-type’ Delphi,
used to develop group consensus about the relative importance of the issues“
(Okoli & Pawlowski, 2004)
The AHP is well known and most widely applied in solving decision-making
problems (Mousavi, et al, 2013). Decomposition into a hierarchy is based on
previous studies and empirical experiences. In order to decompose a problem
into a hierarchy, a researcher needs to consult previous experiences and at-
tempts for a particular topic of interest. The criteria and subcriteria are not each
equally important to the decision at each level of the hierarchy, and each alter-
native rates differently on each criteria. AHP can provide an analytical process
that is able to combine and consolidate the evaluations of the alternatives and
criteria by either an individual or group involved in the decision-making task.
The further strength of the model lies in its ability to recognize incosistent judge-
ments (Chen, 2006). Combined with Delphi method it provides a framework for
solving different types of multi-criterion decision problems based on the rela-
tive priorities assigned to each criterion’s role in achieving the stated objective
(Tornjanski, Marinkovic, Jaksic, & Arsic, 2015).

4. Empirical results and discussion

Next paragraphs present the data obtained from the Delphi and AHP studies,
followed by analysis and discussion on the research results. In addition, the
results of the Delphi method are tested using a statistical analysis to confirm
the reliability of the given results of the Delphi method.

4.1. The application of the Delphi method in the study

The first and second round of surveys in this study was conducted using the
Delphi method. The goal was to reach consensus among experts about the de-
terminants for optimal location selection in the ICT industry which were grouped
into three contexts that are synthesized based on thorough literature review.
This study was implemented using web-based questionnaires and the consen-
sus was considered adequate if 70% of experts agreed on each determinant.
The same experts were involved in round 1 and round 2 of the Delphi. Experts
were individuals on management positions in the ICT companies. They were
asked to rank the importance of determinants for an optimal location selection
in the ICT industry in which their response reflects subjective attitude based on
their knowledge and experience. A five-point Likert scale was used to evaluate
the importance where: 1 = unimportant; 2 = slightly important; 3 = important; 4
= very important; 5 = critical. Further, an open question was also given to the
participants for comments or suggestions at the end of the questionnaire.

100
Fifteen (15) ICT management experts from 6 IT companies were asked to par-
ticipate in this study, and ten (10) took part in it, resulting in the participation rate
of 66% in both rounds of the Delphi. The average importance rating, standard
deviation and percentage level of importance for each evaluated determinant
after round 1 and round 2, were obtained using statistical calculation. The most
significant detemrinants as recognized by the experts in the Delphi survey are
further evaluated through an AHP model. The most significant detemrinants as
per Delphi results are presented in Table 2.

The significance of determinants Average value

after II round of Delphi (tn)
Capital investment costs 3.4
Quantitative
Operational costs 4.3
context
Transportation costs 1.9
Political and economic environment 4.2

Qualitative Legal framework 3.9

context Competition 4.1
Suppliers 2.9
Human resource availability 4.7
ICT-specific
Infrastructure availability 3.2
context
Cultural compatibility 3.1

Table 2. Determinants and their significant after the second round of Delphi

In addition to the Delphi method, Cronbach’s alpha test is used to estimate the
reliability of results obtained from the Delphi study. The reliability test was per-
formed on the mentioned determinants after the second round, consisting of 10
elements. The result of Cronbach’s alpha test is presented in Table 3:

Cronbach’s Alpha Number of elements

0.665 10

Table 3. Reliability test result based on Cronbach’s alpha test

The reliability result obtained using Cronbach’s Alpha test shows the value of
0.665, indicating the scale of reliable judgments. Therefore, experts’ judgment
on the importance of determinants for optimal location selection is considered
reliable and may be further evaluated with the AHP.

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4.2. The application of the AHP method in the study
The AHP is used to prioritize the determinants of optimal location selection in
the ICT industry, previously collected through the Delphi method. The research
problem is decomposed into a hierarchy structure that includes the overall goal,
3 criteria and 10 sub-criteria, as shown in Figure 2.

Figure 2. Structured AHP hierarchy for development of optimal location selection

model in ICT industry

The highest level of the hierarchy is the overall goal, in this case, optimal loca-
tion selection in the ICT industry. Below the overall goal, the next level repre-
sents the most significant criteria which influence this decision, including: quan-
titative context (F1), qualitative context (F2), ICT-specific context (F3).
As seen in the Figure 2, there is total of 10 sub-criteria placed at the bottom
level of the hierarchy. The factors related to quantitative context consists of
three sub-criteria: capital investment costs (F11), transportation costs (F12),
and operational costs (F13). Factors related to qualitative context are the fol-
lowing four sub-criteria: political and economic environment (F21), legal frame-
work (F22), competition (F23), suppliers (F24). For the ICT-specific context the
following three sub-criteria are considered: human resource availability (F31),
infrastructure availability (F32), cultural compatibility (F33).
Once the structure of the problem has been designed, the prioritization of each
element started in order to determine the relative importance of each. Prioriti-
zation procedure implies the pairwise comparison of elements at the same level

102
and in regard to elements of the upper level of the hierarchy. Once all elements
at both levels (Level 1 represents criteria, and Level 2 represents sub-criteria)
were compared by the experts, according to the AHP procedure, the matrices
are constructed.

4.2.1. Results of Level 1 evaluated criteria

Based on the results obtained from the Delphi study, ICT-specific context (F3)
is important in comparison with quantitative context (F1) and moderately im-
portant in comparison with qualitative context (F2). Quantitative context (F1) is
important compared to qualitative context (F2).

F1 F2 F3
Deciding on an optimal location
selection in the ICT industry Quantitative Qualitative ICT-specific
context context context
F1 Quantitative context 1.00 0.33 0.5

F2 Qualitative context 3.00 1.00 1.00

F3 ICT-specific context 2.00 1.00 1.00

∑ 6.00 2.33 2.50

Table 4. Judgment comparison matrix of criteria relative to the main goal

Table 5 illustrates the calculation of results that includes assigning the local
weights according to the distributive way of calculation, resulting in the prioriti-
zation of criteria at Level 1 for successful decision on optimal location selection
in the ICT industry.

Deciding on an
optimal location Priority
F1 F2 F3 ∑a*ij Weights
selection in the ICT vector
industry
F1 0.17 0.14 0.20 0.51 0.16943252 17%

F2 0.50 0.43 0.40 1.33 0.44306152 44%

F3 0.33 0.43 0.40 1.16 0.38750596 39%

Table 5. Vector of eigenvalues of comparison matrix and weight calculation based on

Saaty’s eigenvector procedure for criteria at Level 1 relative to the overall goal

Priority of criteria at Level 1 relative to the main goal is as follows: F2 – F3 – F1.

Based on the Delphi results, the highest priority in the selection of optimal busi-
ness location in the ICT industry refers to the qualitative context (w=0.44), fol-
lowed by the ICT-specific context (w=0.39). Quantitative context (w=0.17) has
the least priority according to the results.

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Consistency ration was calculated to ensure the coherence of the judgments
respectively.
Consistency ratio of the pairwise comparison matrix is calculated as 0.017,
which is less than 0.10. Therefore, the weights are shown to be consistent and
the comparison is acceptable.

4.2.2. Results of Level 2 evaluated alternatives

Next steps show the analysis of evaluated alternatives at Level 2 towards the
corresponding criteria placed at Level 1 in the AHP model. Table 6 shows the
results of evaluated alternatives relative to the quantitative context (F1).

F11 F12 F13

F1 Quantitative context Capital Operational Transportation
investment costs costs costs
Capital
F11 1.00 0.33 5.00
investment costs
F12 Operational costs 3.00 1.00 8.00

F13 Transportation costs 0.20 0.13 1.00

∑ 4.20 1.46 14.00

Table 6. Judgment comparison matrix of sub-criteria relative to the criteria related

to the quantitative context

Based on the Delphi results, the highest priority related to the quantitative con-
text in the selection of optimal business location in the ICT industry refers to the
operational costs (w=0.66), followed by the capital investment costs (w=0.27).
Sub-criteria related to transportation costs (w=0.07) has the least priority ac-
cording to the results.Consistency ratio of the pairwise comparison matrix is
calculated as 0.067, which is less than 0.10. Therefore, the weights are shown
to be consistent and the comparison is acceptable. Table 7 shows the results of
evaluated alternatives relative to the qualitative context (F2).

104
 F21 F22 F23 F24
F2 Qualitative Political
context Legal
and economic Competition Suppliers
framework
environment
Political and
F21 economic 1.00 2.00 1.00 5.00
environment
Legal
F22 0.50 1.00 1.00 4.00
framework

F23 Competition 1.00 1.00 1.00 5.00

F24 Suppliers 0.20 0.25 0.20 1.00

∑ 2.70 4.25 3.20 15.00

Table 7. Comparison matrix of sub-criteria relative to the criteria of qualitative context

The results of pairwise comparison of sub-criteria at Level 2 in relation to the

qualitative context (F2) shows that political and economic environment (F21)
is moderately important in comparison to the determinant that refers to legal
framework (F22), equaly important to sub-criteria related to competition (F23),
and strongly important compared to determinant related to suppliers (F24).
Further, the sub-criteria related to legal framework (F22) has equallyimpor-
tance compared to sub-criteria related to competition (F23), and moderately
important compared to suppliers (F24). Further, competition sub-criteria (F23)
is stronlgy important compared to sub-criteria related to suppliers (F24). Table
contains the calculation of local weights results, which implies the prioritization
of the alternatives at Level 2 against the qualitative context at Level 1.

Factors related
Priority
to qualitative F21 F22 F23 F24 ∑a*ij Weights
vector
context
F21 0.37 0.47 0.31 0.33 1.15 0.3844862 38%
F22 0.19 0.24 0.31 0.27 0.73 0.24432643 24%
F23 0.37 0.24 0.31 0.33 0.92 0.30605483 31%
F24 0.07 0.06 0.06 0.07 0.20 0.06513253 7%
Table 8. Vector of eigenvalues of comparison matrix and weight calculation based on
Saaty’s eigenvector procedure for sub-criteria at level 2 relative to the criteria F2

Priority of criteria at Level 2 according to the quantiative context is as follows:

F21 – F23 – F22 – F24 Based on the Delphi results, the highest priority related
to the qualitative context in the selection of optimal business location in the ICT
industry refers to the political and economic environment (w=0.38), followed by
the competition (w=0.31), followed by legal framework (w=0.24). Sub-criteria
related to suppliers (w=0.07) has the least priority according to the results.

105
Consistency ratio of the pairwise comparison matrix is calculated as 0.029,
which is less than 0.10. Therefore, the weights are shown to be consistent and
the comparison is acceptable.
Next steps show the analysis of evaluated alternatives at Level 2 towards the
corresponding criteria placed at Level 1 in the AHP model. Table 9 shows the
results of evaluated alternatives relative to the ICT-specific context (F3).

F31 F32 F33

F3 ICT-specific context Human resources Infrastructure Cultural
availability availability compatibility
Human resources
F31 1.00 5.00 6.00
availability
Infrastructure
F32 0.20 1.00 1.00
availability
Cultural
F33 0.17 1.00 1.00
compatibility
∑ 1.37 7.00 8.00

Table 9. Judgment comparison matrix of sub-criteria relative to the criteria

related to the ICT-specific context

The results of pairwise comparison of sub-criteria at Level 2 in relation to the

ICT-specific context (F3) shows that human resources availability determinant
(F31) is strongly important in comparison to the determinant that refers to infra-
structure availability (F32) and strongly important related to sub-criteria related
to cultural compatibility (F33). Further, the sub-criteria related to infrastructure
availability (F32) has very equal importance compared to sub-criteria related to
cultural compatibility (F33). Table 10 contains the calculation of local weights
results, which implies the prioritization of the alternatives at Level 2 against the
ICT-specific context at Level 1.

Factors related to Priority

F31 F32 F33 ∑a*ij Weights
ICT-specific context vector
F31 0.73 0.71 0.75 2.20 0.731997677 73%
F32 0.15 0.14 0.13 0.41 0.138066202 14%
F33 0.12 0.14 0.13 0.39 0.129936121 13%

Table 10. Vector of eigenvalues of comparison matrix and weight calculation based
on Saaty’s eigenvector procedure for sub-criteria at level 2 relative to the
criteria F3

Priority of criteria at Level 2 according to the quantiative context is as follows:

F31 – F32 – F33. Based on the Delphi results, the highest priority related to

106
the ICT-specific context in the selection of optimal business location in the ICT
industry refers to the human resources availability (w=0.73), followed by the
infrastructure availability (w=0.14). Sub-criteria related to cultural compatibil-
ity (w=0.13) has the least priority according to the results. Consistency ratio
of the pairwise comparison matrix is calculated as 0.017, which is less than
0.10. Therefore, the weights are shown to be consistent and the comparison
is acceptable.

4.2.3. Results of final prioritization

Next steps show the analysis of evaluated sub-criteria at Level 2 towards the
overall objective in AHP model. Table 11 depicts the final ranking expressed
in percentage of priority sub-criteria at Level 2 relative to the overall goal, i.e.,
optimal location selection in the ICT industry.

OVERALL PRIORITY
OF SUB-CRITERIA
SUB CRITERIA PRIORITY
IN RELATION TO
THE MAIN GOAL
Human resources
W F31 0.2837 28.37% 1
availability
Political and economic
W F21 0.1704 17.04% 2
environment
W F23 Competition 0.1356 13.56% 3
W F12 Operational costs 0.1115 11.15% 4
W F22 Legal framework 0.1083 10.83% 5
Infrastructure
W F32 0.0535 5.35% 6
availability
W F33 Cultural compatibility 0.0504 5.04% 7
Capital
W F11 0.0463 4.63% 8
investment costs
W F24 Suppliers 0.0289 2.89% 9
W F13 Transportation costs 0.0116 1.16% 10

Table 11. Final prioritization of sub-criteria in relation to the overall goal

According to the obtained results presented in Table 11, the first priority in an
effective decision related to optimal location selection in ICT industry is hu-
man resource availability with priority vector of 28.37%. Experts in Serbia are
of the opinion that second priority should be placed on the political and eco-
nomic environment with a ranking of 17.04% towards the overall goal. The
third priority should be placed on a competition with priority vector of 13.56%.

107
These three together account for 58.97%, making them more important than all
other sub-criteria combined. Still, sub-criteria related to operational costs and
legal framework account for 11.15% and 10.83% respectively, which makes
them a significant determinant in relation to the overall goal. On the other hand,
other sub-criteria such as operational costs, legal framework, infrastructure
availability, cultural compatibility, capital investment costs, suppliers, transpor-
tation costs have a lower degree of the accomplishment of the main goal in
the AHP. However, these should still be taken into account when considering a
decision of optimal location selection in the ICT industry.

5. Conclusions
The goal of the study is to prioritize determinants for the decision regarding
optimal location selection in the ICT industry. The purpose of this paper is to
demonstrate and emphasize the importance of location selection in the ICT
industry as a key success factor for sustainable growth and development of the
ICT industry in the 21st century. In predicting a long-term survival and growth, a
location has always played a vital role. Due to a shortage of supply and fierce
competition in the ICT sector, over recent years the concept of location selec-
tion has been recognized as a key success factor for sustainable growth and
development of ICT organizations.
According to the obtained results presented in Table 11, the first priority in an
effective decision related to optimal location selection in ICT industry is human
resource availability with priority vector of 28.37%. Experts in Serbia are of the
opinion that second priority should be placed on the political and economic
environment with a ranking of 17.04% towards the overall goal. The third pri-
ority should be placed on the competition with priority vector of 13.56%. These
three together account for 58.97%, making them more important than all other
sub-criteria combined.
Still, sub-criteria related to operational costs and legal framework account for
11.15% and 10.83% respectively, which makes them a significant determinant
in relation to the overall goal. On the other hand, other sub-criteria such as op-
erational costs, legal framework, infrastructure availability, cultural compatibili-
ty, capital investment costs, suppliers, transportation costs have a lower degree
of the accomplishment of the main goal in the AHP. However, these should still
be taken into account when considering a decision of optimal location selection
in the ICT industry.
It comes as no surprise that human resource availability has the highest pri-
ority. According to the report from European Commision: “employment of ICT
specialists in the EU-28 has resisted the effects of the downturn of uncertainty
on global labor markets, and remained on an upwards path. Growth in the em-
ployment of ICT specialists averaged 3 % over the ten-year period 2006-2015,
more eight times higher than the average growth rate for total employment over
the same period.” (European Commission, 2017)

108
Second importance in priority has the political and economic factors. This is a
very interesting outcome of the study. According to the same report: “In recent
years, EU policies have given greater attention to ICT skills, and in particular to
the employment of ICT specialists. The recently updated Digital Single Market
strategy emphasizes the need for policies designed to boost stability in Eu-
ropean labor markets and improve the EU’s competitive position.” (European
Commission, 2017). This suggests that indeed, political and economic strate-
gies are starting to play a bigger role in ICT market, as governments are getting
more interested in this industry. In Serbia, the government even named ICT as
one of the key priorities of development.
Finally, this study acknowledges potential limitations despite the relevance of
the obtained results in terms of the optimal location selection choice in the ICT
industry. One limitation of the research study is the participation of one group of
stakeholders, i.e., management professional in ICT companies in Serbia. Other
stakeholders might have different views, requirements related to the optimal
location decision, i.e., shareholders, customers etc. Another limitation of the
research paper is the focus on the participants from only one country. Conse-
quently, the study results may not be directly applicable to each other country.
Finally, the research was focused on mainly outsourcing software companies,
while there can be another type of ICT companies with different business mod-
els for which this model for optimal location selection would not be applicable.
Future research on the optimal location selection in the ICT industry should
incorporate perspectives from more various stakeholder group. Moreover,
the results should encompass a larger number of experts from more diver-
sified ICT companies based on their business model. These insights may
reveal additional useful information regarding the optimal location selection
in the ICT industry.

109
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 CHAPTER 6

Reindustrialization as a basis of
new development paradigm in transition countries

Anđelko Lojpur1, Ana Lalević Filipović2

ABSTRACT

Transition “vortex” and radical changes that, in the global context, occurred in the real
economy at the end of the 20th and the beginning of the 21st century, inevitably imposed
the need for a more serious re-examination of the existing conceptual bases, equally
economic sciences and its dominant practice. When it comes to transition countries,
especially if we focus more closely on the Western Balkans, there is almost an undi-
vided opinion that the impact of the deindustrialization process for them was as radical
as the “arrival” of socialism, so many indicators testify to the so-called “Reformation”.
As a logical consequence of the globalization of the imposed natural flow of things, a
significant number of those who believe that the starvation of the industry is in most of
the countries in transition is over. In the sense of the previously cited, the key question
arises: can countries in transition ever reach the standard of living of most developed
market economies?
We intend to point out in this paper the necessity of stopping the reindustrialization
process and raising the level of national competitiveness of the countries in transition
and living standards of citizens. In countries in transition, though with delay, it implies
the problem of finding a new development paradigm, that is, designing new industrial
policies and their revival in the form of a re-industrialization process.

Key words: transition countres, development, globalization, reindustrialization,

competitivenes

JEL classification: L6

1. Introduction
When it comes to globalization, in addition to being one of the key phenome-
na of our time, it is undoubtedly a complex economic, political, historical and
social issue whose essence is worth studying further. This process is particu-
larly important in terms of the evolving developments and the future of the less

1 Full professor, University of Montenegro, Faculty of Economics, Jovana Tomaševića 37,81 000
Podgorica. Scientific affiliation: management, Phone: +382 20 241 138. Fax: +382 20 244 588.
E-mail:andjelko@ac.me
2 Associate professor, University of Montenegro, Faculty of Economics, Jovana Tomaševića
37,81 000 Podgorica. Scientific affiliation: accounting, finance. Phone: +382 20 241 138. Fax: +382
20 244 588. E-mail:analf@ac.me

113
developed countries, with no concern for the large regional community. Warn-
ings of this kind are not from yesterday, let’s say a jade of them: “Experience
tells me that I believe that it is more likely that Europe will become a historic park
for the well-being of Americans and Asians, but the most dynamic world, as it
has proclaimed”; John Naisbitt. At the same time, it turned out that in a global
context, ever-more intense competition threatens survival, just as enterprises
that are not able to transform, be innovative, productive and able to respond to
pressures from the environment as well as to entire national economies.
Equally, advocates and antiglobalists agree that the globalization of the econ-
omy and society as a whole has become the dominant characteristic of mod-
ern capitalism and the verified determinant of success at the global level. We
worry that when it comes to most transition countries, we do not have a clearly
defined development concept, especially when it comes to different starting
points, the functions from which it is observed, and the consequences. Namely,
as K.Ohmae points out, “the global economy has its own dynamics and its log-
ic, because it is no longer a theory, but a reality. The greater the possibility that it
will continue to emerge, but weaken, “(K.Ohmae, 2007). We think that countries
in transition can not stay on the side of the mentioned processes, they are evi-
dent laws that imply that they themselves will come up with their own develop-
ment strategy. Other experiences can be useful to them, but conceptual devel-
opment frameworks must respect the existence of a “new economy” and focus
on their own comparative advantages. The pragmatic attitude forces us to raise
a crucial question in the introductory part of this paper - what is our (countries
in transition) today’s true reality, and what is the outlook? Is it possible to reduce
the development gap between this group and a group of developed market
economy countries by re-opening and intensifying the industrialization process
(reindustrialization)? Can these countries, at least, avoid “bad” and maintain
“good” consequences of a total phenomenon such as globalization?

2. Globalization process - imperative or challenge

for earth in transition
Equally, practice and theoretical research show that globalization offers more
opportunities for large companies and national economies that succeed in com-
peting with the competition in the global market. So often, entire national econ-
omies or some of their parts are embedded in global currents, which further
weakens them, while at the same time strengthens the power of the “global
economy” and empowers “debt slavery,” and so on. Prof. LJ. Jurčić points out
that global processes are a chance and a limitation to the development of na-
tional economies, but “in the nature of things, big economies are benefiting,
while globalization spills spread across a large number of small countries (LJ.
Jurčić, 2014). Unfortunately, there is still not a small number of supporters,
who, like in the time of the “Great Depression” some 80 years ago claim that
“there is no need to worry, the markets are only regulative and, if they do, the
economy will be restored.”

114
Consistent with the disassociation of the myths of globalization, J. Stiglitz points
out that what economic policymakers and developing countries should consider
as an unquestionable legitimacy is that if globalization failed to reduce poverty,
it did not succeed in securing stability (Stiglitz, 2016). And not only that, ine-
quality has become the Achilles heel of modern economies, so that despite the
impression that today’s networked economy offers the same chances to every-
one, it is evident that further deepening of the gap in terms of development
and inequality in wealth between developed and less developed countries. T.
Piketty, as one of the possibilities, is dominated by the above-mentioned dis-
crepancy in the inequality that continues to deepen, is seen as follows: “Poor
developed economies compensate for productivity lag and increase national
income by adopting a method of production and skills that can be compared
with those in developed countries.”(see: T.Piketty; 2014). Otherwise, the past
transitional, multi-century experiences show that neoliberal market fundamen-
talism is based on a firm belief in “free markets”, imposed over the past thirty
years as an ideological political doctrine in the service of economic interests.
However, it turned out that as the prevailing ideology and branch of economic
theory that had already burst into the forefront from the end of the seventies, it
has never been fully confirmed in economic theory, and today it is clear that it
has not been confirmed by historical practice (see: J. Dušanić, 2015).
Taking into account the current phase of globalization, the problem of lagging
behind in the development of the countries in transition, as an outstanding ex-
pert of this issue, Branko Milanović raises another issue closely related to the
subject of this paper, which is: “Can societies coexist with people with different
levels of income and consumer spending habits to stay democratic and sta-
ble?“In the end, in view of the many dilemmas that the globalization process
carries with itself, it seems logical to see whether the less developed countries,
in the conditions of ever more intense globalization, are trying to make a radical
break with the past in the form of a new development paradigm?
It is evident that transition countries in newly emerging transition and transition
economies have failed to effect production factors, ie comparative advantag-
es they have (land, labor, capital), resulting in lower achievements of “poten-
tial income”. In support of the thesis that it is a “failing reform” in a significant
number of countries, we emphasize the statement of prof. D. Judic, who is a
good connoisseur of transition, where, on the example of Serbia, states that
her main problem is the so-called “ output gep; ie the level of economic activ-
ity that is below the objectively possible level. “Serbia’s economy is impotent
and scandalized”; “Also, the environment (regulation + institutions + prevailing
strategy of economic entities) in which economic policy is implemented is not
adequate. This particularly applies to institutions such as the Securities Com-
mission, the financial market and the central bank, as well as the mentality of
business entities in the so-called. “Burazerska privatizacija”, concludes prof.
Đuričin (see: D.Đuričin). We also add the opinion of prof. LJ. Jurčić states that
“many countries are in crisis, not as victims of the global economic crisis, but as

115
a consequence of the lack of active industrial policy”, with deindustrialization,
the author continues, “the consequence of leaving the national economy” to the
invisible hand “situation when smart countries have clear industrial policies and
goals “(LJ. Jurčić, 2014).

3. The development perspectives of the earth in transition

in globalization conditions
With the onset of the transition process in the late 1980s and early 1990s, the
former socialist, mostly less developed countries, simultaneously found them-
selves under the severe and uncertain blows of the globalization process that
imposed itself as the dominant determinant of success at the global level. At
least this is a bit clearer because of the expected prosperity and a structural
adjustment program that should have been reflected in a better standard of
living for citizens in most transition countries, especially those who without ac-
cepting the “ten commands” from the “new economic bible”, established on the
dominant policy of liberal economic ideology advocated by the IMF, the World
Bank, and the like.
In the sense of the previous indictment, if today’s nearly three-quarters long
transitional achievements are estimated and the same comparison is in line
with expectations, it is noticeable that most transition countries have similar
problems that have all the characteristics of crisis strikes that have little or no
flow of time. Some of them are: a) a drastic fall in industrial production; b) a
high deficit of the balance of payments, c) a reduction in domestic investment
in production capacities; d) high external indebtedness; e) unbalanced budget,
f) high unemployment and impoverishment of the majority of the population;
g) low salaries of employees and other income of citizens; h) clientelism as an
engine of corruption; i) late, slow progress and insufficient progress in institu-
tional reforms, j) unfavorable demographic trends; k) overcoming affirmation of
polycentric spatial development; l) slowly solving accumulated ecological prob-
lems, etc. Better to say, the globalization of this type and the “introduction” of
the market economy in the majority of economies that were in transition from
communism to the market did not bring the promised results to the political
elites. Whether the previously mentioned is that many other inherited charac-
teristics have been favorable to the rise of corruption to the all-encompassing
state, then the absence of the rule of law (so-called rule of law), disregard for
property rights, and so on, are still clearer reasons why the so- In spite of the
modest effects, the market reform still and in almost all transition countries is
considered to be flawed and completely uncertain.
There is no doubt that the globalization of the economy and society as a whole
has become the dominant characteristic of modern capitalism, and thus the
verifiable determinant / success at the global level. With this, any reliance on
the emerging order is meaningless, so that the losing countries are the only
ones left to accept the reality and start the process of their own restructuring

116
 in accordance with the valid rules at the global level. Guided by this under-
standing, in this paper we will focus more on its economic aspect, dealing with
more positive and negative impacts on „small” economies, or even closer to
the domestic reality of the countries in transition. Furthermore, this means that
we will look into the answer to the question, can, and how, small underdevel-
oped economies survive in the conditions of the growing globalization intensity
that is manifested in the dramatic increase in inequality between developed
and underdeveloped countries, between the rich and the poor in each coun-
try separately, then There are also overcrowding, ecological disasters, mass
migrations, ethnic conflicts and more. Additionally to the previous question,
(T.Pikettty,2014), who is genuinely concerned with the issue of inequality in the
distribution of wealth by the essence of globalization, explores the following:
„Are we quite sure that an economy that is based on” free market „and private
ownership always and everywhere leads the optimal distribution? „An expert,
Nobel laureate J.Stiglitz sees globalization as a trap in terms of the overall de-
velopment of society, emphasizing that since today’s globalization, many poor
people in the world have no benefit, and neither does it benefit either nature or
stability of the world economy (J.Stiglitz, 2004). By doing so in the context of the
largely negative aspects of globalization, he asks, „How did it happen that the
process that was supposed to bring benefit to everyone - and developed and
developing countries - now everyone is attacking?”
These flows and processes are controversial and contradictory. In our opin-
ion, there is a huge and unimaginable change, and with the flow of time an
increasing part of us is convinced that the change is up. In this sense, the
intensity of connections, that is, the level of globalization and its consequences
on the global level is the subject of numerous analyzes and controversies, and
the simplest can be presented in the form of the so-called „ Global Index of
Globalization (KOF), which includes three sub-indices: economic, social and
political, Table 1.
Herzegovina
Netherlands

Montenegro
Bosnia and

Country/
Macedonia
Romania
Slovenia
Hungary

Slovakia

Index of
Albania
Croatia

Serbia
Cezch

Globalisation

Global 1 9 16 17 32 35 36 46 55 59 88 93
Economical 4 7 12 15 40 44 55 53 79 32 102 64
Social 5 23 20 21 42 43 47 61 66 71 105 101
Political 9 49 44 42 50 46 28 75 64 120 90 144

Table 1. Ranking of countries by index and globalization sub-indices

117
According to the Globalization Index (KOF) for 2016 - Table 1; The following
countries are the most globalized: the first is the Netherlands, followed by Ire-
land, Belgium, Austria, Switzerland, Singapore, Denmark, Sweden, Hungary,
Canada, Finland, Portugal, etc. Regarding the countries in transition, some of
which have already become members of the EU, the order is as follows: Hun-
gary is the first in the global list to rank ninth, followed by Slovakia (16); Czech
Republic (17); Poland (22); Lithuania (29); Bulgaria (30); Slovenia (32); Croa-
tia (35); Romania (36); Serbia (46), Bosnia and Herzegovina is in 56th place;
Montenegro at 59; Macedonia at 93 place, etc. If this indicator is brought into
line with indicators such as the level of global competitiveness, GDP per capita,
etc., it is concluded that better results have been achieved by those countries
that have significantly engaged and accepted the principles of globalization so
that, generally speaking, could say that globalization is not, in principle, an ob-
stacle to development. Examples of such countries can serve as models of de-
velopment followed by the so-called. “Asian tigers” (South Korea, Hong Kong,
Taiwan), as well as other emerging industrialized countries that are swimming
in the waves of globalization, have managed to get closer and reach the level
of development of the leading highly developed countries. Based on an insight
into the global ranking, it has been confirmed that the state does not have to be
large, nor rich in natural resources to be successful. Also, there are examples
of some of the most populous countries in the world such as China and India,
which in the conditions of globalization implemented deep and comprehensive
reforms of the economic system. This suggests that the dynamics of the devel-
opment of individual national economies will depend more and more on their
own ability and perseverance to raise their competitiveness on the basis of a
fuller effect of knowledge and that this is possible if that group of countries suc-
ceeds in more fully effecting its existing and “ new comparative advantages. In
the long run, the main force that truly leads to greater equality is the spread of
knowledge and skills (T.Piketty, 2014).
Furthermore, given the objective of the work, special attention is paid to the key
issue raised in one of the recent reports of the European Bank for Reconstruc-
tion and Development, which reads: “Can countries in transition ever meet the
standard of living of most of the developed market economies?” In this docu-
ment it is clearly stated that the economic growth of this group of countries is
still below the pre-crisis level, that many of them “turned their backs” to reforms
that could raise the economy of the countries of the former Eastern Bloc. The
aforementioned “shock”, as the report further states, raises doubts about the
ability of these countries to return to the right track of reforms, jeopardizing their
ability to catch up with developed countries when it comes to living standards.
In order to search for the answer to the question of whether there was a real
progress in transition, one good estimate of what really happened to the “fall
of socialism in the early 1990s” is given by prof. LJ. Jurčić says when he says
“history is definitely bent on liberal capitalism, marking it as the undisputed
winner and the universal model of the future arrangement of the world. It
was some kind of a conservative revolution that was portrayed as a historical

118
 necessity and which, by the power of the “invisible hands” of the free market,
would provide the people of the world with stability, peace and prosperity. The
development of a society (the state) is understood as a general privatization,
liberalization and deregulation, with economic growth occurring as a natural
result of market automatism “(LJ.Jurčić, 2014). Similar to the previous obser-
vation, and B. Milanović, in his famous analysis of the twenty-five year period
after the fall of the Berlin Wall, points out that only one in ten people living in
transition countries experienced a successful transition to capitalism and more
democracy. In the next part of the paper, we give an overview of a number of
key indicators, based on which a fuller insight into the transition paths across
individual countries is possible:
a) an overview of the size of the market and the economic strength of a
number of countries and the EU; Table 2;
b) a review of GDP per capita in relation to the EU average in 2016; Table 3;
c) ranking of countries in transition according to priorities in the “Strategy
2020”; Table 4;
d) review of the ranking of countries according to the Human Development
Index - HDI; Table 5;
e) comparing the level of competitiveness for the report 2015/16, table 6.

GDP,
Structure of GDP GDP/pc, current
COUNTRIES and current prices,
in world GDP prices, intl. USD
population 2017 mird. USD
2017 2010 2017 2010 2017
Brasil
2.140,94 3,30% 2,75% 10.816 10.308
(209 mil.st.-2,7%)
China
11.795,29 9,30% 15,14% 4.382 8.480
(1.409 mil st.18,7%)
India
2.454,46 2,40% 3,15% 1.475 1.850
(1.339 mil st.-17,7%)
Russia
1.560,70 2,30% 2,00% 11.445 10.885
(144 mil st.-1,9%)
Turkey
793,69 1,20% 1,02% 10.475 9.826
(80.7 mil st.-1,07%)
Montenegro (0,62 mil st) 4,19 0,01% 0,01% 6.684 6.718
Japan (127 mil st.-1,7%) 4.841,22 8,7% 6,21% 44.673 38.281
USA (325 mil st.-4,3%) 19.417,14 23,30% 24,92% 48.310 59.609
EU (510 mil st.-7%) 16.139 25,90% 20,71% 30.388 40.874
TOTAL (7,5mird
77.928,03 100% 100%
inhabitants)
Table 2. Overview of market size and economic strength of a number of countries and the EU

119
 Real personal consumption
BDP
Country according to purchasing pow-
per capita
er standard3
EU 28 100 100
Slovenia 83 75
Croatia 59 59
Montenegro 42 54
Macedonia 38 41
Serbia 36 45
Albania 30 39
Bosnia and Herzegovina 31 41
Table 3. GDP per capita and actual personal consumption in relation to the average of
the European Union

Expected Average GNI/pc

Expected GNI /PC HDI
HDI HDI duration of number of (const
State duration – HDI 2014.
Rank value schooling years. PPP
of life rank year
in year education 2005)
Very high HDI - 51 states; 0,949 – 0,800
1 Norway 0,949 81,7 17,7 12,7 67,614 5 1
2 Australia 0,939 82,5 20,4 13,2 42,82 19 3
3 Switzerland 0,939 83,1 16,0 13,4 56,364 7 2
25 Slovenia 0,890 80,6 17,3 12,1 28,664 13 25
Czech
28 0,878 78,8 16,8 12,3 28,14 11 28
Republic
48 Croatia 0,827 77,5 15,3 11,2 20,291 14 46
48 Montenegro 0,807 76,4 15,1 11,3 15,410 24 49
49 Russia 0,804 70,3 15,0 7,3 76,075 -48 50
High HDI - 54 states; 0,796 – 0,701
56 Bulgaria 0,794 74,3 15,0 10,8 16,261 13 57
66 Serbia 0,776 75,0 14,4 10,8 12,202 22 66
71 Turkey 0,767 75,5 14,6 7,9 18,705 -7 72
75 Albania 0,764 78,0 14,2 9,6 10,252 24 75
81 Should 0,750 76,8 14,2 9,0 10,091 22 82
90 China 0,738 78,0 13,5 7,8 13,345 -7 91
Middle HDI - 40 states; 0,699 – 0,550
111 Egypt 0,691 71,3 13,1 7,1 10,064 -7 111
119 J. Africa 0,666 57,7 13,0 10,3 12,087 -30 119
131 India 0,624 68,3 11,7 6,3 5,663 -4 131
Low HDI – 40 states; 0,541 – 0 352
149 Syria 0,536 69,7 9,0 5,1 2,441 13 145
152 Nigeria 0,527 53,1 10,0 6,0 5,443 -23 151
World 0,717 71,6 12,3 8,3 14,447 - -
Table 4. Overview of countries ranking according to the Human Development Index – HDI3

3 In addition to goods and services purchased directly by households, this indicator also includes services
provided to non-profit institutions and governments for personal consumption (eg health and education
services).

120
 Sustainable
Intelligent growth Integrative growth
growth
State
The environment Education Market. work Social Environmental
Digital agenda Innovative Europe
companies and training and employment inclusion protection
Finland4 4,83 6,15 6,08 6,09 4,73 6,30 5,75
Croatia 3,34 3,99 3,15 4,39 3,37 4,18 4,67
Estonia 4,21 5,30 4,28 5,12 4,88 4,73 4,67
Macedonia 3,95 3,63 2,78 4,01 3,80 3,95 3,19
Hungary 3,49 4,03 3,37 4,47 3,76 4,09 3,59
Lithuania 3,81 4,63 3,65 4,90 4,43 4,27 5,48
Montenegro 3,88 3,91 3,34 4,28 3,69 4,62 4,76
121

Poland 3,72 3,98 3,43 4,85 3,87 3,89 4,07

Romania 3,61 3,61 2,98 3,95 3,68 3,79 3,94
Serbia 3,16 3,66 2,70 3,80 3,33 3,69 3,84
Slovenia 3,53 4,30 4,25 4,88 3,90 4,98 5,17
Turkey 4,20 3,45 3,53 4,28 3,59 4,38 3,36
Table 5. Rank of the countries in transition according to the priorities set in the “Strategy 2020”4

4 Finland was taken as the first-ranked country.

 Bosnia and
State Switzerland Montenegro Serbia Croatia Slovenia
Hercegovina
Global Competitiveness Index GCI – Rank 1 107 82 90 74 56
Basic requirements 2 94 86 87 68 38
1st pillar: Institutions 6 126 80 115 89 58
2nd pillar: Infrastructure 6 105 76 74 46 39
3rd pillar: Macroeconomic stability 4 76 119 103 84 58
4th pillar: Health and basic faces. 8 50 60 53 66 16
Efficiency enhancers 3 106 79 90 67 54
5th pillar: Visions. And training 4 92 64 69 49 22
122

6th pillar: Efficiency of the commodity

6 129 74 121 95 42
market
7th pillar: Labor Market Efficiency 1 125 83 106 100 85
8th pillar: Sophistication of the financial
8 101 54 110 95 118
market
9th pillar: Technological Readiness 1 76 52 70 47 35
10th pillar: Market size 39 98 130 74 78 84
Factors of innovation and sophistication 1 122 98 120 92 37
11th pillar: Sophistication of business 1 115 103 125 80 48
12th pillar: Innovation 1 125 94 108 103 33
Table 6. Comparison of competitiveness levels for Switzerland, BiH, Montenegro; Serbia, Croatia and Slovenia according to the report 2016/1.
Regarding the data from the previous tables and the comparison of the ef-
fects of the countries in transition in relation to the developed market economy
countries, their significant lagging behind most of the analyzed indicators is
noticeable, some of which are: a) the development gap between the devel-
oped and the most developed countries of the world and the peripheral the
region is deepening in relation to less developed countries (Table 2); B) EU
participation in GDP globally decreased 25.90% in 2010 to 20.71% in 2017
(Table 2); c) GDP / pc in a number of countries (Russia, Turkey, Montenegro)
has a tendency to decline or stagnate; d) countries in transition, EU Member
States and those at the stage of accession significantly lagging behind in de-
velopment for the EU average (Table 3); e) The best placed country from this
group of countries according to the HDI coefficient is Slovenia in 25th place,
Croatia at 48 and so on. (Table 4); the lagging behind countries in transition is
particularly evident in the indicators set out in the “Strategy 2020”, whereby we
refer to the assessments related to the “digital agenda”, “innovative Europe”,
“education and training”, which indicates that this group of countries does not
have a clear development perspective Table 5); Significant lagging of this group
of countries is also evident in the achieved level of competitiveness compared
to the leading Switzerland, BiH is 102th, Montenegro is 82, Croatia - 74, Serbia
- 90 and so on. (Table 6). Hence, as a logical one, the conclusion is that the
reform process has begun in the countries of socialism, especially in view of
the Western Balkans, stopped in mid-2000 and can generally be regarded as
unfinished. Thus, for example, according to currently projected growth rates,
the economies of the Western Balkans will reduce by only 2030 only a small
fraction of the current difference in relation to income levels per capita in ad-
vanced economies. It is noted that much more inconsistency than the nature of
the reform processes carried out resulted in these countries becoming victims
of their own “reform fatigue”. Worse still, the success in developing countries
so far, if it was, was mainly based on a combination of vast natural and oth-
er domestic resources, government aid, cheap labor or some other inherited
advantages, which we usually refer to as comparative. However, business in
today’s conditions shows that, over time, the comparative advantages that in-
dividual countries have are no longer sufficient to achieve and preserve a high
standard of citizens. As a logic, the consequence is the globalization of the
imposed natural flow of things, in the function of which numerous indicators
are presented that testify to the so-called. “Reformation”, there were not many
who think that the starvation of the industry in the majority of countries in transi-
tion is over. Hence, instead of advocated convergence, the continuation of the
deepening of the gap between developed and less developed countries, which
we pointed out as a problem, shows that the dynamics of the development of
some national economies will increasingly depend on their own ability to raise
their competitiveness to a higher level.

123
4. A new development paradigm as a basis
of the reindustrialization process
With the advent of the global economic crisis, it has been shown that, in ad-
dition to those transition economies, the problem of economic growth and the
creation of additional value, increased incidence, and so on, have developed
countries. According to strategically designed and key documents formalized
by the vision of a European social market economy for the 21st century, the
EU economy should be: intelligent, sustainable and integrative. Presenting the
annual report on the competitiveness of EU members, it was pointed out that
“Europe is emerging from the crisis and signs of slow recovery are visible. Nev-
ertheless, although we have made progress, we have not yet reached the level
we anticipated and which we need to create employment.” that report noted
that the share of production in gross value added creation in the EU fell from
15.8 percent in 2008 to 15.1 percent in 2013. In the same period, about 3.5
million employees lost production jobs, while only Germany had achieved em-
ployment growth in all areas. Consequently, in the context of return to industrial
policies, the notion of “new industrialization” or a shorter “reindustrialization”
was again “revived”, with the overall objective of revitalizing the EU economy
as a whole, determined by the contribution of the GDP industry in 2020 to a
level of 20 percent.
Furthermore, in the aforementioned report, it was pointed out that improved
production improves the competitiveness of European industry, better to say, it
is marked as a key driver of job creation and economic growth. This implies all
solutions leading to increased productivity (production speed, operational pre-
cision and raw material and energy consumption), and / or reducing waste and
pollution of the manufacturing industry, both in traditional and in new sectors
of industry. Examples include: sustainable production technologies, intelligent
production with the help of information and communication technologies and
high performance production. In the same report they are in the function of
the necessary increase of competitiveness in the EU member states, as the
following recommendations are key:
1. First, more investment is needed in all sectors of the economy;
2. Second, growth requires investment, and investments need capital;
3. The third message is that we (EU) should emphasize the importance of
innovation for growth;
4. The fourth message is that Europe is lagging behind in competitiveness
due to high energy prices;
5. The fifth message is an imperative for European firms to have better
access to markets and fully integrated into the global value chain; and
6. The sixth message is imperative that EU member states improve the
quality of public administration, the inefficiency of public administration
and the legal system is recognized as a key obstacle to improving EU
competitiveness.

124
The current situation, characterized by stagnation in growth, low competitive-
ness, high unemployment, a decline in the share of manufacturing and industry
in general in GDP, undoubtedly support the emphasis on economic growth as
a key priority. Thus, e.g. the participation of industry in GDP in the period 2001-
2009. years in Slovenia decreased from 30.1% to 25.5%; in Romania from
28.2% to 25.3%; in Croatia from 20.4% to 18.3%, Serbia from 21.6% to 18.0%
and the like. Prof. Ž.Primorac points out that at the end of last year, and espe-
cially at the beginning of this century, there were major changes in the industrial
development plan in its conceptual view in the way that “traditional industries
are suppressed and replaced by new technologies, based on new materials,
smart software, high-performance production robotics, three-dimensional 3D
printers and other technological achievements “(Ž.Primorac, 2013).
Reindustrialization, in the way announced in this paper, does not in any way
means the “defense” of socialism, and even less the appeal of the “centrally
planned economy”, nor even the undemocratic ideology and decline in the trap
of new ideological discussions. On the contrary, it turned out that in today’s
multipolar world there are no embedded development paradigms; the way out
of the crisis of the countries in transition is possible only in the form of a new
order, which, as things stand now, will not have much socialism in itself. In this
sense, we think that as the conceptual directions of the action of governments
in transition countries, united in the form of a development paradigm, they can
signify the following: a) the new role of the state; b) “creative destruction” as
the completion of the “de-industrialization” process; c) new industrial policy; d)
regional clusters; e) abandoning bribes on foreign investments; f) translating
absolute and comparative into competitive advantage; g) reducing inequality;
h) the process of technological convergence; i) the rise of “human capital”; j)
new economic paradigm and reactivation of the entrepreneurial economy. In
the next part of the paper, we will briefly explain each of the following concep-
tual directions:
a) New role of the state. Let’s go to the fact that more and more advocates are
aware that if “development is under the domination of the state, then devel-
opment without the state is completed equally.” The new role of the state
could be described in the shortest way as its abandonment of the role as the
leading entrepreneur and the transition to the function of correcting market
anomalies and failure. In this sense, our starting point is that “the state is
wrong”, but that the market is more sinful than the state. Nevertheless, both
the attitude and the “anti-market” and “anti-state” have something in com-
mon, which is to restrain and take control of the “crazed” financial capitalism
and fundamentally modernize the tax and transfer system in the center of the
fashionable “welfare state”. Furthermore, each country, which is particularly
important for less developed countries, has special mecanisms to mitigate
the negative consequences of globalization. Thus, for example, no matter
how contradictory it may seem, “globalization has allowed the creation of a
spectrum of regulatory strategies and, in a certain sense, greater activity of

125
 the state than it led to the end of the state. Accordingly, the power of the na-
tional governments is not necessarily reduced by globalization, but contrary
to it - it has been reconstructed and erstructed in response to the growing
complexity of the governance process (V.Vuletić, 2003).
b) “Creative Destruction” (Schumpeter, 1942), as the completion of the process
of “de-industrialization.” The countries in transition to which we have focused
our research are all important features of a small economy, so that they must
be open to the global environment at the same time, to influence internation-
al capital flows and overall trends in the global market, which would mean
a total break with an unproductive “smoke industry”, the shutdown of large
business systems, former socialist giants, which in a number of transition
countries continue to survive mainly due to dominantly non-economic rea-
sons, are “political” and the like.
c) New industrial policies. The affirmation of entrepreneurship in the form of
new industrial policies, not inherited, but those that prove to be meaning-
ful, as a dark social activity should be placed in the focus of the changed
awareness of the future progress and dynamism of the countries in transi-
tion. Argumenet for such an effort finds that developed industrial countries
intervene whenever it is in the interest of protecting domestic industry, and
have opened their markets during decades of development only to the extent
that they have increased the level of their own competitive ability.
d) Regional clusters. Reindustrialization that would indicate the dynamics of
economic growth will not be possible in the extent that continuity in develop-
ment policy continues, especially on the obsolete institutional and organiza-
tional base. In addition, a number of countries can not be timely transformed
into an entrepreneurial economy due to the lack of “economies of scale”, an
unbalanced.
g) Reduction of inequality. The convergence of inequality is possible only by the
gradual establishment of a new development paradigm in which the founda-
tions and the “knowledge economy” will be found. Let’s start with it that it is
quite clear that knowledge and innovations have played a key role in the pro-
cess of civilization development. “The main power is the convergence of the
process of disseminating knowledge and investing in vocational education.
The process of disseminating knowledge and skills is a central mechanism
that at the same time allows for general productivity growth and reduction of
inequality, “T.Piketty, 2014 points out.
h) The process of technological convergence. The concept that we prefer
here implies acceptance of the principles of the knowledge economy, that
is, knowledge and innovation based development policy. The basis of this
strategy consists of four basic pillars (World Bank, 2007): a) workforce, b)
modern and adequate information infrastructure, c) efficient innovation sys-
tem, and d) developed national institutional framework.

126
i) Fourth Industrial Revolution; Industry 4.0. Under the bumps of globalization,
and, to a large extent, as a result of its inability, individual governments be-
came “agents” of large economic monopolies, and shifted the completely
disrupted domestic economic structure to the service sector as the only re-
maining, thus creating numerous developmental problems. We therefore
consider that countries in transition must not “close their eyes” before the
“fourth industrial revolution” that had already happened in the early twen-
ty-first century. Otherwise, they will in the short term feel all the disastrous
consequences of the so-called. “Technological Darwinism” in which some of
them have been deeply trapped by the devastating and uncontrolled “dein-
dustrialization”.
j) New role of social capital. “If technology is the driving force of a global
economy, to what I firmly believe, then knowledge is its noble metal”; says
K.Ohmae,2007. In fact, here it is practically about the rise of “human capital”,
whereby the starting hypothesis can be stated that a developed strategic ap-
proach to the development of human potentials of a small and undeveloped
country can achieve not only national recognition in regional frameworks, but
also greatly accelerate its economic development.
k) New economic paradigm and reactivation of the entrepreneurial economy.
The idea of ​​reactivating this premise in the process of reindustrialization
is not new, but in reality we have the situation that “entrepreneurship is in
language, and classics in thoughts”. In addition, in most of the transition
countries, the tradition of collective entrepreneurship has caused problems
in the inauguration of in-company entrepreneurship, the start-up of family
businesses, and the like. Evidently low level of entrepreneurship in transition
countries is almost a logical consequence of the realization that the so-called
“ entrepreneurial necessity entrepreneurship, and not if that is the case in
developed countries of a market economy where I predominantly are so-
called. entrepreneurship driven by opportunity (Deakins D. 2012).

5. Conclusion
In the function of searching for answers to the question of whether it is possible
and how to reverse the future concept of development in countries in transition
in the direction of greater world equality in wealth, the issue is again open and
as an “exit of emergence” the possibility of “new industrialization”, that is, re-
industrialization. In that sense, the new model of economic growth should be
basically based on the use of knowledge where it will no longer be so important
maximum rate of growth of social production, forced loyalty, subordination and
hegemony, raw functional authority. It is better to say that the exit from the crisis
of the countries in transition under conditions of globalization is possible only
in the form of a “new” order, accepting the “new” economic development para-
digm in which the so-called “new economy.“

127
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 CHAPTER 7

The effects of the digital revolution on costs and prices

Gábor Rekettye1, and Gábor Rekettye Jr.2

ABSTRACT

The rapid digital development of the fourth industrial revolution will result in drastic
changes both in manufacturing and in business models. The conceptual study intends
to define the expected changes and investigate the intensity of changes of the different
industries, some of them already in the middle of the digital vortex. The main part of the
paper wants to describe the expected future effects of these changes on the costs of
production, within the industries touched directly by the disruptive innovations arising
from the digital revolution. The study also intends to investigate the cost effects on those
fields of the social sphere which are not directly touched by the digitalization. The study
comes to the conclusion that the two limits of price setting i.e. the costs as the bottom
and the customer value as ceiling limit will move in opposite directions in technologically
intensive industries providing with a growing elbowroom for pricing. This development
will have a determining effect on the whole social life.

Key words: Digitalization, disruptive innovations, digital vortex,

costs and prices

JEL classification: M11, M21, M20, O14

1. Introduction
The first two decades of the 21st century have been characterized by turbulent
changes in the world economy and we have reason to believe that this is going
to continue in the future as well. A large number of researchers and scientific re-
search institutes are making efforts to identify the most important global trends
(we might as well call them megatrends) that will determine the future of the
world economy and, closely related to it, the future of mankind (Larsen, 2006;
National Intelligence Council, 2012; Gregosz, 2012; Vielmetter and Sell, 2014;
Hajkowicz, 2015; Bradley et al., 2018, Dobbs et al., 2015, etc.).
Interest in the investigation of global issues is less widespread in Hungary, the
few studies that have been published focus mainly on assumptions about the
future of single industries while global issues are at best discussed at the level

1 Professor Emeritus, University of Pécs, Faculty of Business and Economics, Rákóczi Street 80,
7622 Pécs, Hungary. Phone: +36 30 976 6897, E-mail: rekettye@ktk.pte.hu
2 Associate professor, Metropolitan University, Budapest, Nagy Lajos király útja 1-9, 1148 Buda-
pest, Hungary, Phone: +36 20 772-6071, E-mail: grekettye@metropolitan.hu.

131
of journalism. There is general agreement on the part of experts and thinkers
dealing with the economy and more specifically business life that those who
restrict the validity of their theories to individual countries – however small or
large they might be – are making a big mistake.
Towards the end of the previous millennium it was already possible to observe
in our world turning more and more into a global village the emergence of the
kind of changes that – gathering strength in the first two decades of the first mil-
lennium - regarded all types of separation, or restriction to be short-sighted and
utterly provincial. Those who fail to recognize the increasing interdependence
of markets and national economies, ignore the impact of international process-
es, are in a cul de sac beyond doubt.
The author of the present study - in co-operation with some volunteering re-
searchers – has studied these global issues for several years. An extensive re-
view of international literature has lead them to identify six global megatrends,
that will have a decisive influence on the future changes in the business envi-
ronment. They are the following (Rekettye, Rekettye Jr., 2013): shift in world
power which has already started, demographic changes, proliferation of prod-
ucts and communication tools, changes in consumer behaviour following eco-
nomic depression and the radical acceleration of technological development.
The consequences of power shift have already been analysed in detail as
commissioned by the Marketing Subcommittee of the Hungarian Academy of
Sciences (Rekettye, 2016) and now attention is focused on digitization, the
driving force of the radical acceleration in technological development as well
as its effect on business life. This is considered to be of importance because
both the review of literature and consultations with experts in several countries
(Rekettye Jr., 2017) have proved that technological development is of utmost
importance even though the trends outlined here are closely interrelated.
This trend is so strong that references to a fourth industrial revolution have al-
ready appeared. This study focuses on the essence of this industrial revolution
(Industry 4.0) describing the characteristics of the so-called disruptive innova-
tions that - as a result of digitization - appear like a vortex and get multiplied.
Their effect on costs and prices will also be examined.

2. Industrial revolution 4.0

The compound ‘fourth industrial revolution’ is actually the title of a book written
in 2016 by Klaus Schwab, founder and current leader of the World Economy
Forum. (Schwab, 2016). In his view the world has now entered a stage of tech-
nological development, which can very well be called a revolution and this is
a change (development) which might overwrite former trends, determine our
whole life, and as such, it can have a fundamental influence on the production
of customer value, the factors motivating it, the methods of its implementation ,
its results and consequences. Figure 1. shows the changes in production over
the last two-three centuries.

132
Figure 1. The industrial revolutions
Source: Own construction

At present it is impossible to foresee the consequences of the fourth industri-

al revolution. Let us examine what kind of changes we have to do with. The
VINTlabs research team at the Sogeti Research Institute (Vision, - Inspiration
– Navigation – Trends) described as early as in 2013 that the bricks used for
building the ‘smarter world’ - community media, smart phones, analysing skills,
cloud applications complemented with the internet of things now constitute a
coherent and co-operating system, that makes it possible for us to make our
things smarter or create smarter things (SMACT Figure 2).
The fourth industrial revolution was also the leading topic at the World Eco-
nomic Forum in Davos, 2016 with the title: Mastering the Fourth Industrial Rev-
olution. The forum discussed both the positive and the negative aspects of the
fourth industrial revolution. As Schwab put it: „There has never been a time of
greater promise, or peril”. The opportunities arise from what the SMACT theory
defines by saying that the building bricks of a more optimal life constitute single
system by now.

133
 Figure 2. Components of SMACT (with the date of their introduction)
Source: https://www.sogeti.com/why-us/leading-innovation/

Note: SMAC is the acronym used by the Gartner Research Institute in the re-
search project entitled: Nexus of Forces, and VINTlabs added T for the Internet
of things.
John Moavenzadeh analysed another aspect of this development in his paper
presented at the 2015 summit meeting in Amsterdam. He stated that the fourth
industrial revolution fundamentally transforms the global system of production.
The emerging cyber-physical system combines communication, information
technology, data, physical elements and a host of basic technologies, recep-
tors, the infrastructure of communication via the internet, intelligent, simultane-
ous processing, the participants of mechanical activities, the ‘big data’ and the
way it can be obtained, the automated operation and management systems,
advanced robotics, 3D and 4D printing.
It is on this basis that the business models of industry will change fundamental-
ly. A survey conducted in 2015 involving strategic leaders of companies found
the following:
• 88% of experts working in the car industry believe that by 2030 at least
one car manufacturer will realize higher income from the sale of data and
services than from the sale of cars and spare parts.;
• 92% of banking experts agree that the so-called ‘distributed ledger’ tech-
nology will have eroded the whole financial system;
• the majority of institutional investors and financial leaders agree that by
2025 most of the transactions, and even company documents will be
processed in the blockchain system (Peplow, 2016)

134
In conclusion it is reasonable to forecast that IT (Information Technology) will
get integrated with OT (Operation’s Technology) (Figure 3) which, in turn,
will lead to a paradigm change in operation as a consequence of M2M (ma-
chine-to-machine) communication. The resulting Internet-based cyber-physical
systems will induce favourable changes in the creation of customer value or
– as Francois Barbier one of FLEXS’s managers put it: The fourth industrial
revolution will change the way we produce and consume.

Figure 3. The linking of IT and OT

Source: based on (Bloem et al., 2014)

3. Proliferation of disruptive innovations — the digital vortex

The rapid development of digital technology will bring about a paradigm change
in production and will affect not only the individual companies, but the competi-
tiveness of the countries as well (Baur et al., 2015; Rüβman et al., 2015; Geiss-
bauer et al., 2016, Berger, 2016). What can be observed already is the fact that
the digital technology favours the so-called disruptive innovations.
A large number of examples could be mentioned to illustrate this point. One of
them, perhaps the most spectacular, is the industry built on photography. Tak-
ing photos on celluloid film flourished for more than a hundred years when, in
the 21st century, is was replaced at a rapid pace by the digital camera. It is ironic
that the Kodak company – inventor of the digital camera - insisted on going on
with the production of the old product too long and went bankrupt as a result.
But manufacturers of digital cameras could not quietly rest on their laurels ei-
ther, because smart phones appeared in 2007 and they took hardly one decade
to fully replace the digital camera (Figure 4).

135
Figure 4. Smart phones oust digital cameras (global sale of digital cameras in m pieces
Source: statista.com

For some industries digital disruptive changes mean the introduction of new de-
velopments, new ways of meeting consumer needs either by companies within
the industry or external ones (e.g. start-ups) which jeopardize the present posi-
tion of the industry as a whole.
Once this process begins, it takes up more and more speed, and like a vor-
tex, sweeps along the companies. Certain studies refer to this period starting
around 2012-15 as the era of digital vortex. In this context we should mention
the book entitled ‘The Digital Vortex’ by Loucks et al, which obtained the Axiom
Business Award Prize in 2017.
The digital vortex represents great danger for some but excellent opportunity
for others. As Bradly and al wrote: ‘Economists may very well argue about
the advantages of digital technology for productivity, this debate is, however,
overshadowed by the fact that buyers (both individual consumers and organi-
zations) unquestionably enjoy great advantages in value - lower costs, better
performance, new relationships’ (Bradly et al., 2015a: 10).
Not every industry is exposed to the effects of the digital vortex to the same
degree. The Global Business Centre for Digital Business Transformation, a re-
search centre operated by IMD and Cisco found the following order among the
industries in 2015 (Figure 5).

136
 12. Pharmaceuticals
11. Oil & Gas
10. Utilities
9. Healthcare
8. CPG manufacturing
7. Hospitality & Travel
6. Education
5. Telecommunication
4. Financial Services
3. Retail
2. Media & Entertainment
1. Technology

Figure 5. Order in which industries are exposed to the digital vortex (1 = most exposure,
12 = least exposure).

This order can, of course, change in no time; a company may be on the edge
of the vortex today, but fall suddenly in its centre or vice versa.

4. The effect of industrial revolution 4.0 on prices

Manufacturers have to bear in mind two limits when setting the price of a prod-
uct or service: the lower limit is defined by the costs (in the short run variable
unit costs and in the longer run the total unit costs), while the upper one de-
pends on the consumers’ willingness to buy and their price acceptance. It goes
without saying that the latter is deeply influenced by the size of the perceived
value that the product or service represents for customers at the target market.
If the price does not fall between the two limits the product cannot be sold or
if it can, it will make a loss. As demonstrated in our earlier papers (Rekettye,
1997, 1999), these limits gradually move away from each other in the case of
technological goods, (Figure 6) thereby giving more elbow room to price policy.

137
 Figure 6. The elbow room available for prices
Source: own construction

4.1 The effect of the fourth industrial revolution on

the lower limit of pricing
The term lower limit of pricing actually means the costs. In the long run the prof-
itability of a company depends on whether the price allows the return of all the
costs per unit, while in the case of price actions in short term business policy a
return of variable costs per unit can be sufficient. If a product can be manufac-
tured at lower costs than before, we speak of improved productivity. Looking
back on the history of industrial revolutions we can see that each resulted in a
huge improvement in productivity. Just think of emergence of mass production
or the consequences of automation.
Now, at the beginning of the fourth industrial revolution all forecasts point in the
same direction: in the next 10-20 years an unprecedented, radical improvement
of productivity can be expected, which means that the unit costs will decrease
significantly, of course to various degrees in the different industries. Let us ex-
amine now to what extent the various cost elements will be affected in these
processes. Röβmann et al. made calculations concerning the production of
spare parts in Germany and concluded that
-- on the average direct labour costs will decrease by 30%, over the
present values within the next 5-10 years;
-- a decrease of similar magnitude can be expected in the costs of
operation;
-- Costs of materials will remain unchanged, but forecasts speak of a
50% decrease in moving goods and materials, and logistics;
-- overhead costs are supposed to decrease by 30%

138
 -- It takes, however, significant investment to create the “clever factory”
and this will increase the rate of depreciation – by about 40% forecasts
say. This is the only cost component which is supposed to increase.
-- In conclusion they forecast a 5-7% decrease in total costs, and a
27-30% decrease in conversion costs (with materials excluded).

At this point we have to make two digressions:

• The first is about the impact of productivity improvement and the cost
decrease on the labour market. Speaking about labour costs we can
forecast that the sum of money paid as wages will go down because very
few employees will be needed in the ‘smart factory’.
Machines will do the work like in Okuma, the Japanese machine factory that
is capable of working round the clock, seven days a week, without any human
intervention. All the operators do is supervise the system and the work they
do requires very highly qualified people. (Dujin, Geiisler, 2016: 7). They also
succeeded in automizing the kaizen method which is very popular with the
Japanese, and as a result, the productivity of the factory got multiplied. It is this
side of the fourth industrial revolution that Schwab referred to as great potential
danger. Some researchers think that in the USA, for example, about half of the
people employed in the industry have to face the danger of losing their jobs
to the machines. This ratio is even higher in the developing countries, which
specialize in contractual manufacturing with little value added.
More optimistic forecasts expect new jobs to be created in general, or in com-
plementary services. This, however, would require significant changes in the
qualification and attitude of the labour available. In this context Erik Brynjolfs-
son, professor of MIT (Massachusetts Institute of Technology) made the fol-
lowing statement in an interview on the BBC: ‘The concern is that we are not
updating our education, training and political institutions to keep up.” And this
may lead to a situation where we lose a lot of people. (Gray, 2017).
• The second digression deals with the cost changes in areas not affected
directly by the fourth industrial revolution. The fourth industrial revolution
will make a distinguishable impact in all areas of the society. There are,
however certain corners where this impact will not be very strong. As-
pects of culture should be mentioned here, some parts of education, and
health services, etc. These are the fields where human participation will
remain decisive in the future as well.
The question is, whether the decrease in costs will be experienced in these
activities as well. Well, the answer is found in the theory named ‘cost disease’
advocated by the late William Baumol. This theory holds that the increase in
productivity of manufacturing has made possible – and quite understandably
goes hand in hand with – a rise in the wages of employees. Using Baumol’s
example, it is clear that a string quartet cannot be expected to increase pro-
ductivity, but if their salaries had not been raised, they would certainly have
abandoned their career and taken a job in industry. (Lee, 2017)

139
Productivity increase in the manufacturing industry makes it possible to lower
prices in this sector, but – at the same time- wages are also raised. This, in turn,
makes pay rise in the labour-intensive services indispensable and – to finance
it – the simultaneous increase in prices as well.

4.2. The impact of the fourth industrial revolution on

the upper limit of pricing
The upper limit of pricing policy is the buyers’ willingness to accept the price.
The marketing literature describes in detail that consumers’ buying decisions
are mainly affected by perceived customer value, making it the primary deter-
minant of their willingness to purchase. The perceived customer value is the
result of the customers’ careful comparison of the perceived benefits of the
product or serves and the perceived expenditures they have to make to acquire
the product or service in question.
The analysis of the economic history seems to prove that the industrial revolu-
tions, the development of the industry and the growing number of innovations
have all contributed gradually to increasing the benefits of the offered products.
This process has become more radical in the fourth industrial revolution. The
joint application of the tools (SMACT) listed in the first half of the paper makes
it possible to

• involve customers already in the early stage of product development,

and make more customer-friendly products in this way;

• The time needed for product development is reduced considerably by

the simulation tests and 3D printing, therefore the product gets ready to
be launched in a significantly shorter time;

• The use of robots and the elimination of human work wherever possible
makes the quality of the product much better;

• Digitalization and the use of loT in particular, can add new functions to
the product which facilitate its use, and make its use not only safer but
more enjoyable as well;

• The new technology will be able to customize products more cheaply.

In summary we can conclude that in areas affected by the technology, a rapid

growth can be expected in customer value which is a decisive component in the
upper limit of pricing. It is also clear that while the lower limit moves downwards,
the upper limit moves upwards and these changes lead to a rapid extension of
the elbow room available for the pricing policy.

140
4.3. Expectations concerning price changes
The main question is how prices will change in the industries affected by tech-
nology. Will they follow the decrease in costs and go down, or will they rise be-
cause customer value increases? Let us examine what happened in the past.
Figure 7 shows price movements in some product groups over a period of 36
years in the US.

Figure 7. Changes in the price of some products in the usa between 1980-2016
Source: Vox, Bureau of Labor Statistics

For the most part the American example proves Baumol’s ‘cost disease’ theory.
We can get very similar results if, for example we examine price changes in
Hungary. In a book published a few years ago the authors analysed (Rekettye,
2011) this point and concluded that while the real value of prices of technical
goods fell considerably after the transition, the prices charged for labour inten-
sive services kept rising. Hungarian higher education and the health services
could not be investigated for obvious reasons, this is why driving licences were
found to have the highest price rise.

141
As far as our present discussion is concerned, the main point/question is what
is happening in the conditions created by the disruptive innovations of the fourth
industrial revolution. The study concludes that the same trends will continue,
but at a quicker pace. To what degree prices will follow the decrease in costs,
depends on several factors:
1. What kind of power relations will prevail at the market of the industry in
question, and who will dominate the market;
2. What will be the outcome of the hide-and-seek game of prices between
the suppliers and customers (Rekettye, Liu, 2018);
3. What kind of business policy will be dominant in the industry under
examination.

5. Summary: possible business policies in the era

of the digital vortex
Companies already in the digital vortex can be divided into two large groups.
Disruptors and disrupted. Disruptors and those on the defensive while waiting
to be disrupted can chose between two business policies to follow. Both busi-
ness policies derive organically from the chain of thoughts written about the
lower and upper limits of price policy:
• Price-centred business model: followers of this business policy intend
to create value for the customers by putting price-cuts in focus because
they believe that lower the prices the more they can help them reach a
competitive edge.
• Value-centred business model: The other alternative is to make efforts
to gain a favourable position in the competition by offering products with
higher customer value than the competitors.
The price-centred business model is the one that disruptors prefer to use main-
ly at the beginning their activity. Sometimes they apply novel, unconvention-
al management methods – for example in the supply chain, human resource
management, and most of all in manufacturing and pricing – because these
methods promise them a cost advantage. Several of these methods can be
observed in our days already.:
• Get something free: This method is mainly used in telecommunication.
Customers are not charged anything for products that earlier cost mon-
ey. This practice can be adopted in cases when variable costs are rel-
atively low and marginal variable cost is close to zero. Good examples
are Skype (audio and video calls), Spotify (music) or Dropbox (online
storing). Customers are, however, expected to pay for higher level, pre-
mium services.

142
 • Cost sharing: Users divide the costs among themselves (for example
Groupon).
• Fostering hard bargains: Trivago could be the best example for that (trav-
els, accommodation).
• Inverse auction: In this case the price is set by the buyer.
• Pay as you go: Instead of the former fixed price, buyers are only charged
for the part of the product or service that they have used.
Value-centred business models intend to provide customers with higher cus-
tomer value (more modern products, more comfort, etc.) in addition to low-
er prices. Businesses operating in the vortex follow the basic principle that
they should digitalize everything that can be digitalized. This is the reason
why we often experience that something which used to have a physical char-
acter, can now be linked with the product as a service. Here are some of
the methods applied:
• possibility to test the product free of charge,
• eliminating intermediaries, involvement of buyers in the sale
(do it yourself)
• complete customization
• introducing new digital functions on the products
• making products available very quickly and comfortably,
• making purchases very easy, etc.
The two models are not separated so clearly from each other in real life. Most
of the companies prefer to use the principles of both models simultaneously.:
they increase customer value of their products while keeping low their unit cost.
However, this management method is not always simple to realize.
If companies are to be successful in the conditions of the fourth industrial revo-
lution and the digital vortex, they will have to get to know, accept and implement
a number of new things. One thing is certain: sticking to the old, familiar meth-
ods – that were built on the slow and gradual transformation of the environment
is as good as a death penalty (Hansgaard and Mikkensen, 2013). Because it
is a new reality. All this has an effect on the transformation of company organi-
zation structures, managerial practices, and company culture.

143
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145
 CHAPTER 8

More than technological evolution:

organizational and business impact of Industry 4.0

Nedeljko Štefanić1, Heri Bezić2, Petar Gregurić3

ABSTRACT

Industry 4.0 is a new paradigm enabled by the implementation of digital technologies in

business processes, and it is regarded as the transformation from individual and cen-
tralized processes to flexible, self-regulated and connected process through the use of
cyber-physical systems. Most of the recent literature deals with technology features of
Industry 4.0 while the business and organizational aspects are substantially less cov-
ered. This fact motivates the need to systematize current knowledge on the subject
and to outline potential research directions. Our goal was to address this challenge
by reviewing available papers on topics of organizational and business models in the
context of Industry 4.0 in order to assess the impact of digitalization on current models.
Specifically, we have investigated which current organizational models are more suita-
ble for digital transformation and what are the expected challenges regarding business
models. In addition, we were also interested in what way are organizational and busi-
ness issues addressed in proposed frameworks for digital transformation. Research
findings imply that Industry 4.0 will have a major impact on existing organizational and
business models, with the concrete organizational changes depending on factors such
as industry type, geographical location or current organizational models. These findings
lead to the conclusion that there won’t be a one-fits-all solution that will facilitate the
digital transformation. The used transformation framework will have to take into account
specific organizational circumstances.

Key words: Industry 4.0, Organizational model, Business model,

Transformation framework

JEL classification: JEL_L6, JEL_O3

1 PhD, full professor, University of Zagreb, Faculty of Mechanical Engineering and Naval Archi-
tecture, Ivana Lučića 5, 10002 Zagreb, Republic of Croatia. Scientific affiliation: affiliation1, affilia-
tion2, affiliation3. Phone: +385 1 6168 321. E-mail: nstefan@fsb.hr.
2 PhD, full professor, University of Rijeka, Faculty of Economics, Ivana Filipovića 4, 51000 Rijeka,
Republic of Croatia. Scientific affiliation: affiliation1, affiliation2, affiliation3. Phone: +385 51 355
148. E-mail: heri.bezic@efri.hr.
3 bacc.ing.mech, University of Zagreb, Faculty of Mechanical Engineering and Naval Architecture,
Ivana Lučića 5, 10002 Zagreb, Republic of Croatia. Scientific affiliation: affiliation1, affiliation2,
affiliation3. E-mail: pgreguric@fsb.hr.

147
1. Introduction
The process of globalization, liberalization of international trade and the global
economic crisis in 2007 showed that the classical vision of the enterprise and
its business activities can’t survive in today’s turbulent economy. It is the reality,
not only for production-oriented enterprises, but for service-oriented enterpris-
es too. Because, today’s enterprise needs to have a high degree of specializa-
tion in its field, and, at the same time, a flexible and fast response (new product
or service) to the needs of customers (a very specific ones and a wide range
ones). That creates a new vision of a modern enterprise which needs to unite
contradictory requirements: specialization and flexibility.
Since the introduction of phrase “Industry 4.0” by the Germans during Han-
nover Fair in 2011 (Quin, Ying, Grosvenor, 2016), the literature regarding that
topic has risen sharply, but while most of the recent literature deals with tech-
nology features of Industry 4.0 the business and organizational aspects are
substantially less covered. This paper is going to be offering a viewpoint on
most suitable management practices which promote innovation, startup culture
and learning as well as the best organizational and business frameworks suit-
able for Industry 4.0.
Industry 4.0 is going to be characterized by smart manufacturing and imple-
mentation of Cyber-Physical Systems (CPS) (Shamim, 2016). There is the
number of factors connected to the Industry 4.0 including lack of workforce,
society getting older, mass customization, shorter product life cycle, volatile
markets and pressure to reduce costs (Shamim, 2016). Some of them can be
solved by implementing technological features of Industry 4.0, while others, like
lack of workforce and older society by changing organizational and business
features. Level of innovation has been recognized as number one factor for
adapting to the new demands of the markets. R&D and innovation are key pol-
icy components of the Europe 2020 strategy (Eurostat R&D intensity). All this
require new innovative leadership style, closest to it is transformational lead-
ership (Investopedia - Leadership) (Transformational leadership) (Ma Prieto,
Pilar Perez-Santana, 2014).
The second big challenge, which will, in addition to technological approach
require organizational approach too is mass customization. Although it utilizes
modularization to simultaneously increase product variety and maintain mass
production (MP) efficiency, there are some limitations to mass customization
(Yi Wang, 2017).
The third big challenge is business paradigm change. From 1960 until 2015
world population has grown from 3 billion to more than 7 billion people. Fur-
thermore, the buying power of each individual tripled in that period. The re-
sult is misbalance between supply and demand side. Neoclassical business
models are getting outdated and unsustainable. New business models need to
be constructed, which will include social and environmental factors (De Man,

148
Strandhagen, 2017: 721-726). Social and political parameters will play a crucial
role in the process of digital transformation. Some say that universal basic in-
come will become necessity (Michael Rander) (Universal basic income).
Making progress in this direction and solving this dilemma would make integra-
tion of businesses with the 4th Industrial revolution, i.e. industry 4.0 much eas-
ier for stakeholders. Horizontal integration of the products, customers, workers
or suppliers, and the manufacturing equipment requires not only technological
approach but organizational and different management approach.
That is why in this paper, we will address the influence of Industry 4.0 and
digital transformation on business models and organizational frameworks and
investigate which one is the most suitable for digitalization process. In addition
to that, we will categorize the best changes and ways for current models to
adapt to the necessary changes and categorize them by industry type and geo-
graphical location. There is no unique solution for all type of organization; they
need to be customized.

2. Methodology
Since Industry 4.0 is pretty new, most of the research on it have been based on
theoretial, not experimental methods. This one is no different. It is challenging
to try to practice new business or organizational concepts because that would
require remodeling businesses and being exposed to risks which most of the
companies are not ready for.
The framework methodology used to develop our model is the step-by-step
process which included systematic literature research and review, summariz-
ing, synthesizing new concepts from old, categorizing them and describing in
which direction should research continue.
We have started the process of searching for the appropriate literature by us-
ing scientific sources such as Thomson Reuters to find the articles with the
keywords: Industry 4.0, digitalization, digital transformation, organizational and
business models, transformation framework. After exploring numerous essays
dealing with this topics, we have decided on the ones best suitable for our re-
search directions. Those are the ones referenced in the introduction part. We
chose the sources based on the ones which explore the combination of tech-
nological innovation needed to pass digital transformation with the organization
and management influence taken into consideration. Furthermore, articles in-
vestigating socioeconomics impact on the Industry 4.0 were especially noted.
After deciding on the literature, next step has been summarizing the most suit-
able concepts for our topic. In summarizing phase, we identified essential ele-
ments and condensed vital information into their own words to solidify meaning.

149
For summarizing we have used a simple method adapted from “Summarizing a
Research Article 1997-2006, University of Washington”4. First, we determined
what our focus is and how this article relates to our paper. We asked ourselves:
-- How reliable are the results?
-- Are any of the results unusual?
-- What does this study contribute toward answering the original question?
-- What aspects of the original question remain uncertain?
After reading for depth, highlighting main points and answering the questions,
we have summarized the essential points and results while keeping an eye on
eliminating wordiness, using specific, concrete and scientific language.
In synthesizing, we have taken key points from the previous phase and grouped
ideas to new concepts and thoughts. Synthesizing takes the process of sum-
marizing one step further. Instead of just restating the crucial points from the
text, synthesizing involves combining ideas and allowing an evolving under-
standing of a text.
The last step was recommending in which direction should the research con-
tinue to understand organizational and business impact of Industry 4.0 better.

3. Results and discussion

3.1 Innovative management

Success in Industry 4.0 is measured in the capability of adapting to changes

and in innovation level. Organizations require smart management and smart
workers. Management style has not changed much since the late 80ties, so
new management paradigms are becoming hot research topic. There is a need
to develop capabilities to manage business models successfully, to access po-
tential market and reach customers, to improve value chain processes and sys-
tems, risk management and legal matters, and strategic management because
of globalization. First and essential parameter companies need to reevaluate is
their capability to innovate. Level of innovation is becoming number one factor
needed to be successful in the following years.
In present times, needs of customers are changing daily, and companies must
be able to innovate and follow those needs fast as possible. Competitors are
becoming more agile, dynamic and proactive. Responding times to competitors
moves will need to become shorter and more responsive. The primary inno-
vation indicator also cited as R&D intensity, shows the proportion of gross do-
mestic product (GDP) dedicated to research and development (Eurostat R&D
intensity). As seen from the graph, expenditure on R&D slowly progressed from

4 How to summarize a research article, http://web2.uconn.edu/ahking/How_to_Summarize_a_

Research_Article.pdf

150
1.77% in 2007 to 2,04% in 2014, but recent figures point to stagnation. Still far
away from 3% target (Eurostat R&D intensity)..

Figure 1. R&D INTENSITY (Eurostat R&D intensity).

If we compare expenditure in innovation globally, EU is still lagging behind

more advanced economies, such as
Japan, South Korea, China and the United States. R&D intensity can be con-
sidered a solid indicator of the potential GDP growth (Eurostat R&D intensity).
Fostering entrepreneurship and creativity is number one challenge to make use
of R&D. However, innovation is not limited to it. Companies can be stimulated
to innovate internally, but it requires a different approach to the employees. A
progressive business environment is vital for the promotion and diffusion of
innovation. It is in direct correlation to the leadership style. Investopedia de-
fines leadership as the ability of a company’s management to set and achieve
challenging goals, take swift and decisive action, outperform the competition,
and inspire others to perform well5.
The last part, “inspire others to perform well” is essential for innovative
management.
For example, Apple Inc. is on the list of most innovative companies in the world.
According to most of the case studies, it is not due to the technical skills of past
Apple’s CEO Steve Jobs; it is due to the leadership style of managers. They
know how to extract best outputs from their employees (Shamim, 2016).
If companies aim to stay concurrent in the age of Industry 4.0, they will need to
adopt special, innovative management style.
The most commonly mentioned management style for Industry 4.0 is trans-
formational. Transformational leadership is leadership approach that causes a
change in individuals and social systems. James MacGregor Burns (1978) first

5 Investopedia - Leadership, https://www.investopedia.com/terms/l/leadership.asp#ixzz5Db3rb

151
introduced that concept. While transactional leadership style is based on “give
and take” relationship, transformational is based on leaders personality and
drive toward change. Transformational managers strive to change organiza-
tional culture.6 Since digital transformation requires new, remodeled business
and organization frameworks, transformational management is more suitable
for doing that.

Figure 2. Transformational leadership

In addition to management being transformational in Industry 4.0., it has to

implement some more parameters to be successful. Those are a specific ap-
proach to hiring, training, grouping, compensation and job design.
Hiring has to be slow and methodologic, testing the candidates’ ability to com-
prehend open concepts and testing their capabilities of thinking outside the
box, personality traits needed for the innovative mindset. Firing has to be swift
when it is evident that individual cannot fit into the organizational structure.
Training programs need to be designed to enhance the innovative capability
(Shamim, 2016: 5309-5316) .
Groups formation should follow Belbin system of 9 roles in it. Innovative man-
agers need to motivate employees by designing objective performance com-
pensation system which is reflecting employees contribution to the company
(Ma Prieto, Pilar Perez-Santana, 2014: 184-208).
Job rotation, flexible working time, the lengthy list of tasks and responsibilities
to the employees promote the climate of innovation. Furthermore, job design
ought to promote teamwork and collaboration (Ma Prieto, Pilar Perez-Santana,
2014: 184-208).

6 Transformational leadership, https://www.langston.edu/sites/default/files/basic-content-files/

TransformationalLeadership.pdf

152
3.2 New organizational models
Manufacturing is a crucial part of today’s society. Production paradigm is now
coming through forth powerful change. In the first industry revolution products
were manufactured based on the demands of the user at the limited number
and high cost. In the second industrial revolution, that changed and low-cost
products were made using large-scale production. The variety of the products
was very limited. The leading pioneer of production in Industry 2.0 was Fred-
erick Winslow Taylor. Third industrial revolution introduced mass customiza-
tion production. It required new flexible production paradigm. Lean production
was born from it, including concepts like just in time, pull system and Toyota
production system.
Industry 4.0 brought different demands, shifting focus from company’s value to
customers demands. Customers want personalized products while at the same
time there is a visible deficit of personalized production. In order to solve it,
new smart, modern manufacturing model needs to be invented. China already
adopted the strategy of smart manufacturing and it is called “China manufac-
turing 2025”. Many similar projects are in the world, including “Intelligent man-
ufacturing system” by European Union.

Figure 3. The four stages of the industrial revolution (Veza, Mladineo, Petko)

Customers are demanding products as fast as possible. The delivery time is

going to get shorter and shorter, reducing from a week to days and later to
hours time.

153
For mass customization model to be satisfied it needs to configure various
products variants through modularity with commonality embedded in the prod-
uct platforms to reuse proven design among product families. Furthermore,
products have to be created so the parts of it can easily be modified.
Also for mass customization production to be successful, current organizational
models need to be reassessed.

Figure 4. Mass customization

An organization can range from mechanistic which are characterized by a cen-

tralized structure, bureaucracy, many rules, and vertical hierarchy to organic
which are decentralized, characterized by startup culture, horizontal commu-
nication, and fewer formalities (Shamim et al., 2016: 5309-5316 ). Industry 4.0
is characterized by volatility and uncertainty, so organic design is much more
suitable for it.
Future-oriented companies nowadays are organized in either matrix structure,
decentralized, project-oriented or flat hierarchy.
A matrix type of organizational structure combines the traditional departments
seen in functional structures with project teams. In a matrix structure, individ-
uals work across teams and projects as well as within their own department
or function. For example, a project or task team established to develop a new
application might include engineers and web designers as well as those with
marketing, financial, personnel and production skills7.
Advantages are that it helps break down the traditional departments, improve
communication vertically and horizontally, reduces costs, improve coordination,
induces motivation and encourages synergy of ideas which directly influences
innovation level in the company. At the same time, it brings some disadvantag-
es such as a double line of responsibility, unclear line of authority and members
could neglect their functional responsibilities.
7 Matrix structures, https://www.tutor2u.net/business/reference/matrix-structures

154
Figure 5. Matrix structure

The second common organization structure is a flat hierarchy. It is most of-

ten seen in startups. It has no levels of middle management between staff
and executives. Managers have more employees and responsibilities under
them. Furthermore, chain of command is short, and there is usually no more
than three levels. Open office design is typically seen in flat organizations. The
flat structure increases employee-managers communication, which increases
learning and feedback process. It is reasonable to argue that a flatter organiza-
tional structure can be a good fit with industry 4.0, as it promotes innovations
(Shamim et al., 2016: 5309-5316 ).

Figure 6. Decentralized structure

In decentralized organizational structures, decisions are often transferred to

the lower levels. The main idea is that employees have better knowledge of
activities than top management.

155
It allows them to make decisions faster. In changing times, it has proven to be
more flexible and agile than standard organizational structures (Shamim et al.,
2016: 5309-5316 ).
Industry 4.0, as we mentioned before, requires the new type of innovative man-
agement ready for dynamic and volatile times. This type of management cannot
function in a standard functional organization. It needs new organizational type
which is going to combine matrix and flat structure while being decentralized.
It would allow innovative management to use a full resource of the employees.
By decentralization, employees would become more implemented in decision
making which would make an organization more agile and responsive to the
demands of customers and competition.

3.3 New business paradigm and social-economics results

of Industry 4.0
Digitalization and Industry 4.0 are bringing automation with it. 47% of the U.S.
workforce is at risk of being replaced by automation over the next 20 years8. At
the same time, new jobs will be created – requiring some people to transform
their careers to fit the needs of the new market. However, some people will re-
main unemployed. In 2014, there were approximately 233,700 taxi drivers in the
United States with a 2015 median annual pay of $23,150. No formal education is
needed to become a taxi driver. In the event of a future large-scale automation,
this middle-aged group will not only have no or little formal education, but also no
training that directly positions them for the new jobs in the digital economy. While
some will bounce back, get creative, and start over in new areas, it is a difficult
challenge. Many will not overcome transition (Shamim et al., 2016: 5309-5316 ).
It will bring a profound social effect which Industry 4.0 leaders will have to keep
in mind.
As we mentioned in this working paper, digital transformation is the most pow-
erful revolution happening in the world so far. New management style and or-
ganizational structures will be used to stay competent. However, in addition
to technological, management and organizational approach, social-economical
should also be taken into account.

8 Michael Rander “Is A Universal Basic Income A Must-Have In The Digital Economy?” http://www.
digitalistmag.com/future-of-work/2016/07/05/universal-basic-income-must-have-in-digital-econo-
my-04303867

156
Figure 7. Expenditure on social security

Countries spend massive amounts of money on social security, unemployment

programs, food stamps, housing initiatives, and other social benefits as well as
the resources and administration needed to support these programs (Shamim
et al., 2016: 5309-5316 ). More than 25% of the GDP in European Union (Eu-
rostat, 2017).
An alternative solution is the universal basic income (UBI). It is a fixed amount
given by the state to an all individual at a level sufficient for survival, designed
to prevent society from dividing into two distinct groups: those who can survive
and thrive in the digital economy and those whose jobs are endangered by
digitization9. While that may sound like a massive expense for any country, you
have to consider that UBI would alleviate at least part of the current impact on
social and economic expenses related to unemployment.
Instead of managing and paying out different social security initiatives, the
UBI would offer a less bureaucratic, more transparent, simple and efficient ap-
proach to supporting those in need.

9 Universal basic income, http://basicincome.org/basic-income/

157
4. Conclusion
In this paper, we tried to synthesize the “ingredients” of the future-oriented com-
panies which will dominate the market in the following years. Those companies
will have to contain the mixture of innovative management and new organiza-
tional structure to stay adaptable to change and customer demands.
Furthermore, they will need to move the focus from following the competi-
tion to the satisfying the customers in a way that products or services will be-
come more personalized and customized. Not all the companies will survive
the fourth industrial revolution, the biggest so far. Many of them will not be
able to adapt and as a result, will fail, but the successful ones will become
industry leaders.

158
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asp#ixzz5Db3rb
Ma Prieto, I., & Pilar Perez-Santana, M. (2014). “Managing innovative work be-
havior: the role of human resource practices”, Personnel Review, 43(2),
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http://www.digitalistmag.com/future-of-work/2016/07/05/universal-basic
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Qin, J., Ying, L., Grosvenor, R. (2016) “A Categorical Framework of Manufac-
turing for Industry 4.0 and Beyond”, Elsevier, pp. 173-178
Shamim, S., at al. (2016) “Management Approaches for Industry 4.0-A human
resource management perspective”, IEEE, pp. 5309-5316
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sic-content-files/TransformationalLeadership.pdf
Yi Wang, Y., at al. (2017) “Industry 4.0 - a way from mass customization to mass
personalization production”, Springer, Volume 5, Issue 4, pp. 311-320
Universal basic income http://basicincome.org/basic-income/

159
Figures:
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-and-decentralization
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Ivica Veza, Marko Mladineo, Ivan Petko “Analysis of the current state of Cro-
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fig1_284719780

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-customization-chart/

Matrix organization http://analysisproject.blogspot.hr/2015/07/matrix-organiza-

tion-structure.html
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organisational-behaviour-blog-1/
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l=https://codeburst.io/to-be-a-transformational-leader-you-dont-always-
need-to-be-innovative-you-just-need-to-be-26d5f1cf6cf9

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 CHAPTER 9

Adaptability of the workforce

in Europe – changing skills in the digital era

Maja Jandrić1, Saša Ranđelović2

ABSTRACT

Technological changes have had a large impact on labour markets. New technologies
can either complement or substitute workers. In both cases, one of the most important
consequences is change of set of skills that are needed in the labour market. Problem
solving skills, creativity and socioemotional skills gain much more importance than be-
fore, as well as functional literacy and technical skills related to the use of ICT. Impact of
adoption of new technologies in specific country’s labour market depends on industrial
and occupational structure, the skill mix of the workforce, organization of work and the
extent to which new technology is already present in the local economy. The aim of
this paper is to analyse levels of the workforce skills adaptability in different European
countries, using OECD data on achievement in reading, maths and science, as well as
data on digital competencies, inclusion in lifelong learning and subjective perception on
ability to find a new job. The analysis based od principal component and cluster analysis
showed that there are large differences between the countries, while for some countries
low levels of adaptability of the workforce can pose an important obstacle for future
growth and development.

Key words: labour market, digitalization, lifelong learning, digital competencies

JEL classification: J21, J24, J62

1. Introduction
Contemporary labor market is fundamentally shaped by demographic trends,
accelerating globalization and deepening technological progress. Devel-
oped countries of OECD are facing aging populating, the demographic fore-
casts suggesting considerable further decline of the working-age population
in these countries. Globalization promotes integration of goods and servic-
es markets and paves the way for smoother technological dissemination.

* This paper is published in Proceedings of Rijeka Faculty of Economics-Journal of Economics

and Business/Zbornik Ekonomskog fakulteta u Rijeci: časopis za ekonomsku teoriju i praksu, Vol.
36, No.2, pp. 757-776, DOI: https://doi.org/https://doi.org/10.18045/zbefri.2018.2.757
1 Assistant professor, University of Belgrade, Faculty of Economics, Kamenicka 6, 11000 Bel-
grade, Serbia. Phone: +381113021143. E-mail: maja@ekof.bg.ac.rs
2 Assistant professor, University of Belgrade, Faculty of Economics, Kamenicka 6, 11000 Bel-
grade, Serbia. Phone: +381113021183. E-mail: randjelovic@ekof.bg.ac.rs

161
These developments have several opposing effects on the labor market. In one
hand, lower transaction costs tend to promote development of high value-add-
ed services sector, which is sustained by the demand from foreign markets.
In the other hand, globalization creates incentives for offshoring, services out-
sourcing and increasing exposure to competition of manufacturing labor force
in developed countries, to their lower-cost counterparts in developing countries.
Technological progress leads to automatization of tasks, traditionally performed
by humans. In the last couple of decades this was mostly the case with the
routine tasks, while nowadays, with emerging of Artificial Intelligence, Big Data,
Internet and development of computing power, there is a trend of automation
of more sophisticated tasks and activities as well. Technological advancement
is expected to affect labor market both in developed and in developing econo-
mies. As the developed countries have higher labor costs, they are perceived
as more incentivized to aim at replacing humans with machines in business
operations. However, that risk is also present in developing economies, as full
automation of business operations creates incentives for companies to reallo-
cate manufacturing back closer to their main markets (developed countries).
This hypothesis is supported by the data on the manufacturing employment
data in developing economies, which are facing decline in share of manufac-
turing employment in the early stage of industrialization, thus creating “middle
income trap” risk (Rodrik, 2016).
Automatization, driven by development of technologies, may have a severe
impact on the labor market size, structure and features in the future. It is ex-
pected that in the future, role of workers would be transformed from managing
to monitoring of the machines. At the same time, the key parameters of com-
petitiveness of workers at the labor market will be related to interdisciplinary
skills and creativity, instead of specialization. In terms of the form, life-time jobs
with employment contract and strictly defined working hours are expected to
be increasingly replaced by flexible working arrangements. Technological in-
novations are expected to influence the size of labor market as well. Empirical
studies suggest that 5% of jobs will be questioned due to full automatization,
while for almost two thirds of all jobs, there is a risk of at least partial automati-
zation (Manyika et al. 2016). Risk of automatization will be particularly high in
transportation, logistics, administration, manufacturing and trade sectors (Frey
and Osborne, 2017). World Bank (2016) study shows that the share of jobs po-
tentially jeopardized by new technologies in the Western Balkans, range from
62% in Bulgaria, to over 68% in Macedonia and Romania3.
Digitalization is also expected to put stronger emphasis on the new skills, such
as problem- solving, creativity and communications. According to Cunningham
and Villasenor (2014) the three most wanted skills by employers would be so-
cioemotional (50%), cognitive (29%) and technical (15.9%).

3 These values correspond to estimates that are not adjusted to the speed of adoption of new
technology.

162
Considering the impact technological advancement and digitalization are ex-
pected to make on labor market, the position of an individual at that market in
the future will be substantially shaped by degree of adaptability, i.e. individual’s
employability is expected to be strongly linked to her/his adaptability. Concept
of labor market adaptability refers to the ability of the labor market to provide
protection against uninsurable labor market risk, to provide training in order to
ensure that labor skills continuously match demand as economic development
and technological advance take place and as the international division of labor
evolves, to preserve an efficient degree of geographical mobility and to mobi-
lize labor supply and to ensure a sizeable labor force (Boeri et al, 2002).
This paper is aimed at filling the gap in the empirical literature on the impact of
digitalization on labor market in Europe, by providing the empirical analysis of
the level of workforce adaptability and the quality of skills-mix. In that respect,
we use the Eurostat data on digital competences, inclusion in lifelong learn-
ing, and subjective perception of competitiveness at the labor market, which
altogether describe workforce adaptability, as well the data on PISA results in
science, mathematics and reading. These data suggest positive relationship
between the adaptability and PISA results in Europe. By means of the principal
component analysis and cluster analysis, we find that European countries can
be grouped into three clusters – North and Western Europe, which are high per-
forming, Central Europe and Baltics which are medium performing and South
and Southeastern Europe which are low performing. The results could be used
as an information base for reshuffling of the policies, particularly in terms of
modernization of education, promotion of entrepreneurship, redesign of active
labor market policies and investments in innovations in these countries.
The rest of the paper is structured as follows. In Section 2, data and methodol-
ogy are described. Section 3 provides results of the principal component anal-
ysis and cluster analysis, as well the discussion of the results, while Section 4
concludes.

2. Methodology and data

The Principal Component Analysis (PCA) is used for assessment of the rela-
tive position of 30 European countries according to the levels of the workforce
skills adaptability to the rapid technological changes. The aim of the PCA is to
sum information from larger group of variables into limited group of factors that
cannot be measured directly (Aaker et al., 2008). While transforming original
variables into new uncorrelated variables named factors, it is crucial to keep as
much of the original variability as possible. Since the factors cannot be meas-
ured directly, they are revealed on the basis of the initial variables (Aaker et
al., 2008) and their interpretation is based on their correlations with original
variables. One of the main strengths of this method is that it can summarise a
set of individual indicators while preserving the maximum possible proportion
of the total variation in the original data set. According to OECD, this method

163
is convenient for cross country comparisons, since the largest factor loadings
are assigned to the individual indicators that have the largest variation across
countries, which is a desirable property for cross-country comparisons, as indi-
vidual indicators that are similar across countries are of little interest and cannot
explain differences in performance (OECD, 2008).
To conduct the PCA and cluster analysis, the following data on participation
in lifelong learning, subjective perception of employability, the Eurostat data
on digital competences (2015) and achievement in reading, mathematics and
science from PISA testing (2012) in 30 European countries have been used:4
I. Lifelong learning – participation rate in education and training (last 4
weeks), age 25 – 64;
II. Information skills – Percentage of all individuals who have above basic
information skills in the digital competencies framework;
III. Communication skills – Percentage of all individuals who have above
basic communication skills in the digital competencies framework;
IV. Problem-solving skills – Percentage of all individuals who have above
basic problem-solving skills in the digital competencies framework;
V. Software skills – Percentage of all individuals who have above basic
software skills in the digital competencies framework;
VI. Competitiveness perception – Percentage of the employed persons
who find it easy to find a job of similar salary (European Working Con-
ditions Survey);
VII. Underachieving in reading – Percentage of underachieving 15-year-old
students in reading (PISA);
VIII. Underachieving in mathematics – Percentage of underachieving
15-year-old students in mathematics (PISA);
IX. Underachieving in science – Percentage of underachieving 15-year-old
students in science (PISA)5.
Absence of continual improvement of skills and knowledge through lifelong
learning (variable i) can result in uncompetitive level of skills needed to face
challenges initiated by technological improvement and digitalization. Digital
skills indicators (ii-v) are indicators that, in line with Eurostat methodology, can
be considered as proxy of the digital competences and skills of individuals.

4 Austria, Belgium, Bulgaria, Croatia, Cyprus, Czech Republic, Denmark, Estonia, Finland,
France, Germany, Greece, Hungary, Ireland, Italy, Latvia, Lithuania, Luxembourg, Macedonia (FY-
ROM), Malta, the Netherlands, Poland, Portugal, Romania, Serbia, Slovak Republic, Slovenia,
Spain, Sweden and the UK.
5 Data from 2012 was used due to absence of 2015 data for Serbia. Only for Macedonia and Malta
data from 2015 have been used, since there is no available data for 2012.

164
These indicators are based on selected activities related to internet or software
use performed by individuals aged 16-74 in four specific areas (information,
communication, problem solving, software skills). It is assumed that individuals
having performed certain activities have the corresponding skills. Digital compe-
tence skills framework is disclosed in Appendix (Table A1). Variable vi describes
perception of the employed persons of her/his competitiveness at the labour
market, which may be interpreted as a proxy for subjective perception of labor
market (in)security and employability. Variables vii-ix represent general function-
al knowledge and relates to PISA results in reading, mathematics and science.
On the basis of these original variables, key skill groups (factors) have been
determined, based on which the cross-country comparison in terms of each
obtained factor is conducted. In the next step, in order to detect similar country
groups, the cluster analysis is performed. To check the robustness of the clus-
ter groups, several clustering methods, as well as latent class analysis were
performed (Latent Class Cluster Models).

3. Results and discussion

Prior to analysis, it has been evaluated whether the PCA method is suitable
for identification of factors. In that respect, the Bartlett’s test of sphericity and
the Kaiser-Meyer-Olkin measure of sampling adequacy have been used. Both
the Bartlett’s test and the Kaiser-Meyer-Olkin test have indicated that the PCA
method is appropriate (see the test statistics in Appendix Table A2).

3.1 Principal component analysis

As the PCA method is assessed as appropriate, the next step is to determine
the number of components. This is commonly done by inspection of the corre-
lation matrix eigenvalues: the Cattell scree test and the Kaiser rule. According
to the scree test only those components above the point of inflection on a plot of
eigenvalues ordered by diminishing size should be retained. Kaiser rule recom-
mends that only eigenvalues at least equal to one are retained. Both the scree
plot test and Kaiser rule point to conclusion that two factors should be retained
in the analysis (Table 1). The initial eigenvalues statistics also suggests that two
detected factors explain 85.43% of total variability, which is satisfactory.

165
 Total Variance Explained
Extraction Sums of Squared Rotation Sums of Squared
Component

Initial Eigenvalues
Loadings Loadings
% of Cumulative % of Cumulative % of Cumulative
Total Total Total
Variance % Variance % Variance %
1 5.886 65.402 65.402 5.886 65.402 65.402 4.455 49.496 49.496
2 1.802 20.027 85.429 1.802 20.027 85.429 3.234 35.933 85.429
3 .553 6.146 91.575
4 .399 4.431 96.006
5 .202 2.248 98.253
6 .075 .835 99.088
7 .034 .377 99.465
8 .028 .310 99.776
9 .020 .224 100.000
Extraction Method: Principal Component Analysis.
Table 1. Total variance explained

In order to enhance the interpretability of the results and to obtain a clear pat-
tern of loadings, it is standard practice to perform rotation. As it is plausible to
assume that there is some correlation between the two factors, the oblique
rotation method (Direct Oblimin) is selected as more adequate. However, both
Varimax and Direct Oblimin rotation give similar results and interpretation of the
factors doesn`t change (Table 2).
The correlation coefficients between factors and original variables are called
factor loadings. Table 2. presents the factor loadings for the observed indi-
cators. Factor loadings show how each of original variables correlates with
every factor, while higher values mean a closer relationship. This informa-
tion is then creatively used to identify and name the unobservable factors
(Aaker et al., 2008).
The results indicate identification of two factors and suggest a few conclusions.
The first factor can be interpreted as adaptability/employability, since it relates
to high level of all aspects of digital skills, high participation in lifelong learning
programs and perception that the probability for finding a new job in the next 6
months is high. This is indicated by the values of factor loadings of 0.760 and
more in the Table 2, which show that these variables load highly on Factor 1.
This factor explains 65.4% of the total variability (Table 1). The second factor
may stand for PISA success, since all three relevant variables (PISA results
in reading, mathematics and science)6 load highly on factor 2 (Table 2). This
factor explains additional 20.03 % of the variability.

6 Shares of underachieving 15-year-old students in PISA testing were given with the minus sign in
order to facilitate interpretation of the factor (so that the higher values mean the better results).

166
 Rotated Component Matrixa Pattern Matrixa
Component Component
1 2 1 2
Lifelong learning .818 .835
Information skills .872 .383 .857
Communication skills .900 .971
Problem-solving skills .892 .415 .871
Software skills .814 .325 .807
Competitiveness perception .760 .796
Underachieving in reading .967 .995
Underachieving in mathematics .324 .929 .918
Underachieving in science .972 .998

Extraction Method: Principal Component Analysis.

Rotation Method: Varimax with Kaiser Normalization.a
a. Rotation converged
a. Rotation converged in 3 iterations.
in 4 iterations.

Table 2. PCA results

3.2 Cluster analysis

In the next step countries are grouped in accordance to cluster analysis results.
Generally, cluster analysis encompasses a number of different algorithms and
methods for grouping similar observations into respective categories based
on a set of variables that describe the key features of the observations. Op-
timal number of clusters (3) was determined by hierarchical cluster analysis,
using squared Euclidean distance as a measure of distance and various clus-
ter methods (Ward`s method, Between groups method and Centroid method),
which all led to the same conclusion about the number of clusters. Based on
the previously defined number of clusters, a non-hierarchical K-means clus-
tering was performed. This method, opposite to hierarchical methods, allows
subjects to move from one cluster to another, and it is generally more reliable
in comparison to hierarchical methods (Aaker et al., 2008.). However, K-means
clustering can be very sensitive to the choice of the initial cluster centers. In
this case, the same results have been obtained without any prior specification
of cluster centers and with predefined cluster centers obtained from the initial
hierarchical cluster analysis.

167
Figure 1. Distribution of countries by adaptability/employability and PISA success
Source: Authors’ calculations

Distribution of countries indicates that in terms of adaptability/employability, the

lowest ranking countries are Romania, Bulgaria and Greece, while the best
performing are Denmark, Luxembourg and Sweden. With regards to the men-
tioned elements of PISA score, the top ranking are Finland, Estonia and Po-
land, while the lowest ranked being Macedonia, Bulgaria and Romania. The
scatterplot (Figure 1) also indicates positive relationship between adaptability/
employability and PISA results. For the PISA test results, Macedonia is identi-
fied as an outlier, which may be at least partly explained by the fact that PISA
2015 was the first PISA wave in that country. Therefore, after dropping the
outlier, the cluster analysis is conducted (Table 3)7

Performance Countries
Cluster 1 Low Bulgaria, Cyprus, Greece, Romania and Serbia7
Austria, Belgium, Croatia, Czech Republic, France,
Cluster 2 Medium Hungary, Ireland, Italy, Latvia, Lithuania, Malta, Poland,
Portugal, Slovakia, Slovenia and Spain
Denmark, Estonia, Finland, Germany, Luxembourg,
Cluster 3 High
Netherlands, Sweden and United Kingdom

Table 3. Cluster analysis results

7 If Macedonia were included into analysis, it would belong to Cluster 1, and the position of Greece
would change to Cluster 2.

168
Cluster 3 has the best performances in terms of all selected variables, while
the Cluster 2 outperforms Cluster 1 in all observed variables, at the same
time performing worse than the Cluster 3. Results are also relatively stable
when the K-means clustering is performed on the results of PCA instead on
the original variables – in this case only Belgium moves the best-performing
cluster group, and Malta changes cluster membership to the worse perform-
ing group. The results suggest that the lowest-performing cluster consists of
the South and Southeastern European countries, while the Central Europe,
Baltics and some Western Europe countries belong to the medium-performing
cluster. The best performing cluster consists mostly of the North and Western
European countries.
To overcome the shortcomings of the K-means clustering method (i.e. problems
with sensitivity to outliers, concerns about stability of clusters and sensitivity to
the order in which data is assembled), we also use latent class cluster analysis
(LCCA). The main difference between LCCA and traditional cluster analysis is
linked to the fact that LCCA is model-based and cluster analysis is not (Sch-
reiber, 2017). In LCCA, it is assumed that there is a nominal latent variable with
n categories which are called clusters or classes. LCCA classifies cases into
unobserved subpopulations represented by a categorical latent variable which
is not observed and must be inferred form the data (i.e. from the indicator vari-
ables8) (Pei et al, 2017). This is done on the basis of membership probabilities
estimated directly from the model. The most popular model-based approach
is known as mixture-model clustering, where each latent class represents a
hidden cluster (Magidson, 2005). The optimal subgroup structure that explains
the most variance is determined, while requiring the simplest specification of
the model (Kent et al, 2014).
The models with different numbers of classes are compared using information
criteria (IC)-based fit statistics such as Consistent Akaike Information Criteria
(CAIC), Bayesian Information Criteria (BIC) and AIC3 (Akaike information crite-
rion with 3 as penalizing factor), where lower values of these criteria indicate a
better model fit. While the K-means method itself provides no information about
the optimal number of clusters and therefore involves arbitrary selection, LCCA
gives various diagnostics, which can be useful in determining the number of
clusters. In that way, the decision to adopt a particular model is less subjective.
Another important advantage of LCCA lies in the fact that the items do not need
to have the same scale or equal variances (Schreiber, 2017). Beside larger
classification accuracy, there are also other advantages of LCCA over tradition-
al clustering methods, like better handling missing data problem and provision
of classification probabilities for each case. To determine the most optimal num-
ber of classes, we used IC indices. An initial run of 1-6 clusters was analyzed,
and, in accordance with BIC (Bayes Information Criterion), AIC3 and CAIC, the

8 Indicator variables used to determine latent classes can be continuous, binary, ordered/unor-
dered categorical counts, or combinations of these variable types (Pei et al., 2017).

169
model with 3 clusters was chosen9. All three indices consistently showed that
the three-class model provides significantly better fit, with the lowest values of
BIC, AIC3 and CAIC. The results of the LCCA are presented in Figure 2 and
Table 4.

Figure 2. Cluster means

Source: Authors’ calculations

The Figure 2 shows the means of all indicators across three latent clusters.
It is important to notice that PISA results are given as percentages of under-
achievers, so that the larger values point to the worse results. Cluster 1 has
the lowest mean values for all adaptability/employability indicators (as defined
in PCA): participation in lifelong learning, perception of high employability and
above basic digital competences (information, communication, software and
problem-solving skills), while the percentages of the underachieving students in
reading, mathematics and science in PISA testing are the highest in this cluster.
Cluster 2 has better results in comparison to Cluster 1 in all domains, while
Cluster 3 outperforms both Cluster 2 and Cluster 1.

Performance Countries
Bulgaria, Greece, Romania, Serbia, Macedonia, Italy,
Cluster 1 Low
Portugal and Poland
Austria, Belgium, Croatia, Czech Republic, France,
Cluster 2 Medium Hungary, Ireland, Latvia, Lithuania, Malta, Slovakia,
Slovenia, Spain and Cyprus
Denmark, Estonia, Finland, Germany, Luxembourg,
Cluster 3 High
Netherlands, Sweden and United Kingdom
Table 4. Latent class cluster analysis results

9 It is assumed that for LCA models BIC is a good indicator for which model to choose (Schreiber,
2017; Nylund et al, 2007).

170
Countries’ positions according to cluster groups are shown in Table 4. The
best performing cluster is stable – it is the same as when K-means method
was used. In comparison to the results based on K-means method, only Italy,
Poland, Portugal and Cyprus have changed the cluster groups. Cyprus has
moved from Cluster 1 to Cluster 2, while Italy, Poland and Portugal have moved
from the Cluster 2 to Cluster 1, although some of these countries perform well
in terms of PISA results (e.g. Poland). Other countries have remained in the
same cluster, which indicates the robustness of clustering under different meth-
ods (see Figure 3).

Figure 3. Distribution of countries and clustering

Source: Authors’ calculations

4. Conclusion
Contemporary labor markets are exposed to rapid demographical and tech-
nological changes. The ability of the workforce to make the necessary adjust-
ments to the set of needed knowledge and skills is one of the important fac-
tors that determine in what way will particular country’s labor market react to
technological changes. Effects of these changes can be divided into two broad
groups: (1) creation of the new jobs and destruction of the existing ones under
the influence of automation and robotization and (2) application of new technol-
ogies in the cases when jobs are not susceptible to technology substitution, that
lead to changes in organization and the nature of work. Both aspects lead to

171
significant changes related to the knowledge and skills needed in the labor
market, which points out the importance of constant improvement of the work-
force`s competences. According to analysis based on large set of indicators, 30
European countries are classified according to adaptability and employability
of their workforce, as well as their functional knowledge in reading, mathe-
matics and science, which are considered as essential for full participation in
the knowledge society. Northern European and a number of Western Euro-
pean countries were identified ad the best performing countries in terms of
adaptability, employability and the functional knowledge. On the other side of
the spectrum are countries that generally have very low levels of adaptability
of the workforce. Some of the countries from this cluster have at the same
time high percentages of the underachieving students according to PISA sur-
vey results (Macedonia, Bulgaria, Serbia and Romania). These countries al-
ready have employment and activity rates well below the EU-28, and the low
levels of adaptability of the workforce can impose even larger problems in the
labor markets in the near future. This is particularly important considering the
need to base the future growth on sophisticated, high value-added industries.
In that sense, crucial role belongs to education systems, putting more empha-
sis on creativity, critical and systematic thinking, but also to active labor mar-
ket policies and other measures aimed at fostering implementing the lifelong
learning approach.

172
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Boeri, T. et. al. (2002) Adaptability of labour markets: a tentative definition and
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Cunningham, W., Villaseñor, P. (2014) “Employer Voices, Employer Demands,

and Implications for Public Skills Development Policy”, Policy Research
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Frey, C. B., & Osborne, M. A. (2017) “The future of employment: how suscepti-
ble are jobs to computerisation?”, Technological Forecasting and Social
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Kent, P. et. al. (2014). “A comparison of three clustering methods for finding
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Magidson J., Vermunt JK (2005) “A nontechnical introduction to latent class

models”, DMA Research Council Journal. Available: www.statisticalinno-
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Manyika, J. et. al. (2016) “Non-standard employment and access to social se-

curity benefits”, Research note 8/2015, Brussels: European Commission.

Nylund, K. L. et. al. (2007) “Deciding on the number of classes in latent class
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Pei, L. et. al. (2017) “Using latent class cluster analysis to screen high risk clus-
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 PART 3

ENTERPRISES IN DIGITAL ERA – CURRENT STATE

AND CHALLENGES
 CHAPTER 10

The Use of Information and Communication Technologies

in Enterprises in the Region: Level Achieved
and Further Development

Aleksandra Zečević1, Jelena Radović - Stojanović2

ABSTRACT

In the paper we analyse the usage of information and communication technologies (ICT)
in the enterprises in the countries of the region, namely in: Slovenia, Croatia, Serbia,
Montenegro, Bosnia and Herzegovina, and the Republic of Macedonia. The aim of the
analysis was to examine the level achieved in the ICT usage in enterprises and to ex-
plore the directions for further development. The analysis is based on the data from
statistical offices of the respective countries and on the EUROSTAT data on the ICT
usage in enterprises in the EU Member States for 2017. We analysed the following
indicators of the ICT usage: broadband internet access, employment of ICT specialists,
internet presence (enterprises having a web site), use of social media, use of cloud com-
puting services, e-commerce indicators (enterprises having received orders via Internet
and share of e-commerce in total turnover). Based on these indicators, comparisons
between countries and with the average for the European Union (EU – 28) have been
made. Comparative analysis showed that there are significant differences between
countries in the value of indicators, whereby the EU countries - Slovenia and Croatia
- are the leaders in the ICT use, especially when it comes to e-commerce and cloud
computing services. The development of infrastructure in the countries of the region and
the investments these countries make in ICT, however, give hope that these differences
will be overcome in the near future.

Key words: information and communication technologies, e - commerce,

cloud computing, enterprises

JEL classification: L81, L86

1. Introduction
Countries in the region – Slovenia, Croatia, Serbia, Bosnia and Herzegovina,
Montenegro and The Republic of Macedonia share many common perspectives
of social, economic and technological development. One of them is their mutual
future within the European Digital Single Market. Nowadays, these countries
1 Associate Proffesor, University of Belgrade, Faculty of Economics, Kamenicka 6, 11 000 Bel-
grade, Serbia. Phone: +381 69 44 96 621. E-mail: azecevic@ekof.bg.ac.rs .
2 Assistant Professor, Academy of Criminalistic and Police Studies, Cara Dusana 196, 11 080
Zemun, Serbia. Phone: +381 64 89 22 652. E-mail: jelena.rs@kpa.edu.rs .

177
are its regional segment connecting European Union and Western Balkans. To-
morrow, they will be an integral part of that market. This is a perspective that is
not only imposed on them, but also desired one: imposed, because European
environment has already embraced Digital Agenda for Europe; a desired one,
because the countries themselves are essentially interested in the process of
information society development and inclusion in European digital environment.
The governments of the countries in the region pay great attention to this is-
sue. The governments have adopted information society strategies which set
goals, principles and priorities in the development of the information society
and pointed out the activities to be undertaken on this path. Current Information
Society Development Strategy in the Republic of Serbia until year 2020 has
been adopted by the Government of the Republic of Serbia in 2010. Montene-
gro Information Society Development Strategy until 2020 was adopted in 2016,
in 2017, Bosnia and Herzegovina adopted Information Society Development
Policy for the period of 2017 – 2021 and they plan to adopt Information Society
Development Strategy that would be a key strategic document. In the Repub-
lic of Macedonia, Short-term National IKT Strategy was in power in 2016 and
2017. In Croatia, the current e-Croatia Strategy 2020 was adopted in 2017, and
in Slovenia, Digital Slovenia 2020 – Information Society Development Strategy
until 2020. The goals defined by these strategies are similar: raising the level of
information society development, achieving EU standards set in The European
Commission’s Digital Agenda, integration into European single digital area. The
current strategies are not the first ones that have been adopted. Information
and Communication Strategy – Croatia in the 21st century has been adopted in
2002 and National Strategy for Information Society in Serbia in 2005. Develop-
ment of information society is a spontaneous process that evolves through the
exchange of people, knowledge and information and communication technol-
ogy (ICT) in countries; however, the development is monitored and controlled
by state authorities.
The aim of the Paper was to explore the level of progress in this process,
how successful the previous and current strategies and the efforts made by
countries were and what was the achieved level in ICT usage in the countries.
Therefore, the Paper has considered ICT usage in enterprises which is one of
the two indicators of that process (the other is the usage of ICT by individuals
and households, also monitored by state authorities and international organ-
izations). There are two important aspects of the analysis in the Paper: the
assessment of the achieved level of ICT usage in enterprises in the countries
and comparative analysis – comparisons between countries in the region and
with the European Union (EU – 28). The following indicators of the ICT usage
were analysed: broadband internet access, employment of ICT specialists, in-
ternet presence (enterprises having a web site), use of social media, use of
cloud computing services, e-commerce indicators (enterprises having received
orders via Internet and share of e-commerce in total turnover). Based on the
selected indicators of ICT usage in enterprises, defined and monitored by Eu-
rostat and national statistical offices, the achieved level of ICT implementation

178
by countries was analysed and comparisons among countries and to the aver-
age for European Union ( EU – 28) were made.
The initial assumption in the research was that the existing differences in the
achieved level of economic development between the countries, which were
known from the recent economic history, had reflected on the achieved level of
development and implementation of ICT in the countries, and therefore on the
value of the indicators. The question was whether it was really the case and if
so what were the differences. Finally, the results of the analysis were expected
to show the directions of future development in areas of implementation and
development of ICT in the countries.
After the Introduction, in the second part of the Paper there is a short literature
review dealing with the achieved level of ICT implementation in enterprises in
the countries within the region. As it will be seen, there is not much literature,
especially scientific papers. Therefore the aim of the Paper was to fill the gap
to some extent and encourage future researches on the topic. In the third part
of the Paper, data sources and methodology used in statistical surveys of ICT
usage in enterprises are presented. It is the methodology of Eurostat in Digital
economy and society area. The indicators defined by the methodology were
the basis for analysing the usage of ICT in enterprises in the Paper. The values
of the selected indicators by countries were presented in the fourth part of the
Paper and comparative analysis between countries and with the EU - 28 aver-
age was made. The fifth part of the Paper gives an analysis of research results
and indicates future development in ICT usage in enterprises. As it will be seen,
for some countries future development means improvement in performances
in ICT usage, while for the others, it is still about building an ICT infrastructure.
The sixth part of the Paper – Conclusions – summarizes the results of the anal-
ysis and indicates the future directions of research.

2. Literature Review
Every year, the European Commission compiles European Digital Progress
Report (EDPR) and Country Profile for each member country thus monitoring
the progress of digitisation for each country individually. This report combines
quantitative evidence from the Digital Economy and Society Index (DESI)3 with
qualitative information on country-specific policies. A part of the report, named
Business Digitisation and e-Commerce is dedicated to ICT usage in enterprises.
The European Commission compiles EDPR Country Profile for Slovenia and
Croatia to assess the achieved level in digitisation. In EDPR Country Profile
Croatia for 2017, one of the important conclusions of the European Commission

3 The Digital Economy and Society Index (DESI) is a composite index developed by the European
Commission to assess the development of EU countries towards a digital economy and society. It
aggregates a set of relevant indicators structured around 5 dimensions: Connectivity, Human Cap-
ital, Use of Internet, Integration of Digital Technology and Digital Public Services. See at : https://
ec.europa.eu/digital-single-market/en/desi .

179
is that Croatia lacks appropriate strategies within some areas of digital skills
and practice. In addition, “The country’s greatest challenge in digital is its low
performance in connectivity. Rural broadband connectivity and fast broadband
coverage are limited. Furthermore prices for fixed broadband remain extremely
high.” Among other things, it is estimated that companies lack financial support
in ICT implementation in enterprises. “Croatia does not have a comprehensive
strategy in place. Some funding is available under SME support programmes.
... In spite of the relative absence of national digitisation policies, Croatian com-
panies are medium performers. It would therefore be even more beneficial for
the Croatian economy if Croatia’s businesses could benefit from a targeted
digitisation strategy.” (European Commission, 2017(a), p.8)
EDPR Country Profile Slovenia for 2017 says that “Slovenian enterprises have
considerably stepped up their digitisation efforts. SMEs (small and medium size
enterprises, author’s note) seem to be on right track towards integrating digital
solutions rapidly into their production processes, business models and distribu-
tion channels as selling online enables them to reach out to cross-border mar-
kets. Slovenia has no specific policies aimed at stimulating the digitisation of
business in general or e – Commerce in particular and has not introduced any
specific and targeted fiscal breaks for investment in digital. However aware-
ness of the need to integrate digital technologies into business processes is
rising.” (European Commission, 2017(b), p.8).
Each country in the region individually analyses the achieved level of ICT imple-
mentation in its information society strategy. As a rule, all countries are critical to-
wards the achieved level of development in ICT implementation and believe that
they should move faster. Also, they explore the opportunities for faster progress.
Thus, for example, Montenegro Strategy of Information Society Development
until 2020 distinguishes as an issue the fact that a small number of companies
do not want to use online business concepts. There are reasons given for this:
many companies behave inert, they are satisfied with usual channels of selling
products and services, they do not want to change selling platform, they miss an
ear for new technologies. The Strategy defines strategic development directions
for Montenegro as well as the ways for overcoming this and similar issues: cre-
ating the conditions for electronic business concept, encouraging transformation
of business into digital, introduction of stimulative business environment. Infor-
mation Society Development Strategy in the Republic of Serbia focused on the
analysis of the value of information society development indicators: the aim of
the Republic of Serbia is to reach the EU average till 2020.
National Short-term Strategy of the Republic of Macedonia mainly deals with
ICT business sector and proposes the concrete measures for its improvement:
providing the support to ICT companies, promoting public and private dialogue,
encouraging education in the area. Information Society Development Policy of
Bosnia and Herzegovina emphasizes e-business and the creation of the nec-
essary prerequisites in the form of ICT infrastructure and ICT implementation
improvement in enterprises.

180
There are not many scientific papers, literature on ICT implementation in en-
terprises in the countries of the region. Authors deals with ICT implementation
in enterprises mainly in terms of contribution ICT to company performances,
for example in (Mihalčić, et al., 2015) where the ICT influence on Slovenia
hotel sector competitiveness is analysed. Another example of an analysis of
ICT contribution to economy improvement, this time for Croatia, i.e. a part of it,
Eastern Croatia is given in ((Požega and Pudić, 2014). For Serbia, in a similar
way, (Bradić-Martinović and Zdravković, 2012) the analysis of ICT influence on
business performance in telecommunications, education, manufacture, finan-
cial and insurance activities and retail trade is given while in (Milićević et al.,
2013) the importance of ICT for improvement of companies and tourist agen-
cies operations is indicated.
For Serbia and Montenegro only there are analyses regarding ICT usage in
enterprises. For Serbia, there is an assessment of the achieved development
level of ICT usage in enterprises in (Zečević and Radović-Stojanović, 2017),
where the achieved level of ICT usage in Serbia was assessed as: “Above the
European average, but not at the level of the developed European economies”
(p. 401), however, there are no comparisons to the countries of the region.
For Montenegro, a large research named A Research on the Use of Informa-
tion and Communication Technologies in Montenegro has been made in 2011.
The research was conducted by the Agency for Electronic Communication and
Postal Activities of Montenegro. The research actually presents a detailed anal-
ysis of already published Eurostat indicators in Statistics on the Information
Society. The majority of the research is devoted to the indicators of ICT usage
in enterprises and their comparison to selected countries. The research includ-
ed the comparative analysis by selected indicators with EU, Norway, Turkey
and Croatia (Agency for Electronic Communication and Postal Activities, 2011).
There were no other similar researches for the countries in the region.

3. Methodology and Data Sources

The research on ICT usage in enterprises in the region was based on the data of
country statistical offices: Statistical Office of the Republic of Slovenia (SORS),
The Croatian Bureau of Statistics (CBS), Statistical Office of the Republic of
Serbia (SORS), Statistical Office of Montenegro (MONSTAT), Agency for sta-
tistics of Bosnia and Herzegovina (BHAS) and State Statistical Office of the
Republic of Macedonia (MAKSTAT). Data on the usage of information - com-
munication technologies in enterprises are collected with the annual surveys
conducted by the country statistical offices. Data on ICT usage are available
on Internet sites, in data bases and in publications of statistical offices (press
releases, bulletins, statistical year-books). The analysis is based on 2017 data
and where data were not available, the latest available data were used. Eu-
rostat data on ICT usage in enterprises in the European Union member coun-
tries were also used in the research (section Digital economy and society).

181
These data are available in publications and Eurostat Internet site, as well as
Eurostat Data Base.4
The analysis of the achieved level of ICT usage and comparative analysis
among countries have been enabled by the fact that all surveys on ICT imple-
mentation in enterprises in the countries of the region are conducted based
on standardized methodology. All statistical offices of the countries in the re-
gion have adopted Eurostat concepts and definitions in this area so the applied
methodology in all countries is completely in line with the EU methodology. This
is visible not only in the results, form and the way of data presentation but also
is explicitly specified in publications and methodological instructions, even in
the countries that are not EU members, in: Statistical Office of the Republic of
Serbia (2016), Agency for Statistics of Bosnia and Herzegovina (2017), State
Statistical Office of the Republic of Macedonia (2017), Statistical Office of Mon-
tenegro (2017). Compliance with the EU methodology in the area is a part of
the process of adopting European standards and Eurostat methodology in all
areas of official statistics.
Therefore, data used in the Paper are obtained by the survey on ICT usage
in enterprises that is conducted by the statistical offices according to Eurostat
methodology. The title of the survey is “Usage of Information - Communica-
tion Technologies (ICT) in Enterprises”. This survey collects data on ICT usage
in enterprises, computer use, internet use, e - business and other aspects of
ICT implementation in enterprises. The survey methodology is based on Eu-
rostat methodological instructions in Statistics on the Information Society area.
Methodological instructions include: statistical unit definition, target population,
periodicity, then, definition of observation variables, summary measures, ag-
gregates and indicators, as well as the concepts and nomenclatures as the
additional elements ensuring that statistics are harmonised and comparable
(Eurostat, 2016). The survey was established in 2002 by the European Com-
mission and had been conducted in Slovenia since 2005, Serbia and the Re-
public of Macedonia since 2006, Croatia since 2007, Montenegro since 2011
and Bosnia and Herzegovina since 2015.
In accordance with Eurostat methodology, the observation units in survey are
enterprises with 10 or more employees, dealing with the following activities
according to the NACE Rev.2 classification: Manufacturing, Electricity, Gas,
Steam and Air conditioning, Construction, Wholesale and Retail Trade, Repair
of Motor Vehicles,
Transport and Storage, Accommodation and Food Service Activities, Informa-
tion and Communications, Real Estate Activities, Professional, Scientific and
Technical Activities, Administrative and Support Service Activities, Repair of
Computers and Communication Equipment. Enterprises are classified accord-
ing to the number of persons employed to small (10-49 employees), medium
(50-249) and large enterprises (more than 250 employees).

4 Eurostat Data Base, Digital economy and society: http://ec.europa.eu/eurostat/web/digital-econ-

omy-and-society/data/database

182
Data in researches are collected based on survey’s questionnaires. Survey’s
questionnaires completed by enterprises contain a large number of questions
that are grouped together by the following modules (Eurostat 2016):
-- Use of computers;
-- ICT specialists and skills;
-- Access and use of the internet;
-- Use of cloud computing services;
-- Sharing of information electronically within the enterprise;
-- Sharing Supply Chain Management information electronically;
-- Use of Radio Frequency Identification (RFID) technologies;
-- e- Commerce.
A large number of questions for enterprises is defined within these modules.
For example, the module referring to the Access and use of internet, some
of the questions are: Does your enterprise have access to the internet? How
many employed persons use computers with access to the internet for busi-
ness purposes? Does your enterprise have a Website? Does your enterprise
use any of the social media, etc. The e-Commerce module includes questions
referring to: receipt of orders for goods or services that were placed via comput-
er network or website, value of the turnover and percentage of turnover from e
- sales, information about the difficulties when selling via internet, etc. Survey’s
questionnaire model can be found in (Eurostat 2016).
Enterprises complete the questionnaires by telephone or e-mail. In Slovenia,
for example, the majority of questionnaires is filled out in electronic form and
sent via web. In the Republic of Macedonia, data are gathered via on-line ques-
tionnaire, but also with paper one, sending via mail or e-mail. In Croatia, first,
all participants were contacted by mail with guidelines for completion of web
survey, and so one. The research is conducted on a sample which is as a rule
stratified by size and activity of an enterprise and the scope of sample is rela-
tively large, in 2017 there were 1,673 enterprises in Serbia, 2,483 enterprises in
Bosnia and Herzegovina, 600 enterprises in Montenegro, and so on. In Croatia,
2,889 enterprises took part in the survey (this is the number of enterprises that
responded the survey), while in Slovenia, the sample includes approximately
1,800 enterprises every year.
Data obtained by surveys are published by statistical offices in press releases,
statistical year-books or office data bases. Online access to data base is pro-
vided by statistical offices of all observed countries except Bosnia and Herze-
govina. MONSTAT data base still does not provide data overview in ICT area,
while in MAKSTAT base only a small number of indicators is available. A slightly
larger number of indicators can be found in Serbia Statistical Office Database,
details on Database can be seen in: (Radović-Stojanović et al., 2015).

183
Some countries publish specific publications dedicated to this area, for exam-
ple, since 2015, Statistical Office of the Republic of Serbia has been publishing
a specific publication named Usage of Information and Communication Tech-
nologies in the Republic of Serbia (Statistical office of the Republic of Serbia,
2017), in which data on ICT usage in enterprises have been presented in de-
tails. Slovenia dealt with ICT implementation in enterprises in the publication E
- Skills and Digital Economy (Statistical office of the Republic Slovenia, 2016),
in which the development of information society in Slovenia is presented. The
publication provides data on E-business and E-commerce in enterprises in Slo-
venia.

4. Empirical Data and Analysis

In the Paper, the following indicators were observed as the indicators of the
achieved level of ICT usage in enterprises: broadband internet access, employ-
ment of ICT specialists, internet presence (enterprises having a web site), use
of social media, use of cloud computing services, e-commerce indicators (en-
terprises having received orders via Internet and share of e-commerce in total
turnover). These indicators were selected as the representative ones for each
module in the survey. These indicators are some of the most important ones,
“Key statistics” as it is said in (Statistical Office of the Republic of Slovenia,
2017). There was a problem with indicator names which in office publications
sometimes were not consistent for all countries although they were the same in-
dicator calculated on the basis of the same methodology, Eurostat methodology.
The first observed indicator was broadband internet connection, an indicator
within module Access and use of the internet. It is ICT infrastructure develop-
ment indicator.

Figure 1. Enterprises with broadband access (fixed or mobile), 2017 (% of enterprises)

Sources: Eurostat, national statistical offices

184
Although the percentage differences between countries in the region are not
large they still reflect uneven infrastructure development. A slightly lower val-
ue of the indicator even for the EU – 28 is the consequence of the indicator
low value in some countries – Greece, Romania, Bulgaria (Source: Eurostat
Database, section Digital economy and society). When looking at data for EU
by countries, it can be noticed that island countries, United Kingdom, Ireland,
Cyprus as well as countries with indented coastlines such as, Greece and Cro-
atia have slightly lower values of internet connectivity and speed indicator com-
pared to other countries and the average for EU. Great attention is paid to these
indicators when analysing infrastructure development in countries so EDPR
Country Profile for Croatia has indicated that availability of fixed broadband
connections is below the EU average although it is only one percent - in the
contemporary information world, each percent is relevant.
Regarding the employment of ICT specialists (indicator for ICT specialists and
skills module), the value of this indicator in the region is dominated by Monte-
negro, while Bosnia and Herzegovina and Macedonia have lower percentage
of ICT specialist employment compared to other countries in the region. There
is still a growing demand for specialists in this area, for example, even 43% of
enterprises in Serbia and 66.8% of enterprises in the Republic of Macedonia
declared that they had difficulties employing ICT specialists. Enterprises in EU,
however have no such problems, only 5% of companies there reported difficul-
ties in finding ICT specialists.

Figure 2. Enterprises employed ICT specialists, 2017 (% of enterprises)

Sources: Eurostat, national statistical offices

The largest percentage of website are owned by companies in Slovenia and

Serbia (this is the indicator of Use of computer module), while there is a smaller
number of companies with websites in the countries where the previous two
observed indicators are slightly lower – Bosnia and Herzegovina and the Re-
public of Macedonia.

185
Figure 3. Enterprises having a web site 2017 (% of enterprises)
Sources: Eurostat, national statistical offices

Looking at the way enterprises use their web site, enterprises in the region
mostly use their websites to display the description of goods or services and the
price lists and for personalised content in the web site for regular visitors, while
online ordering or reservation via web site is still low. The situation is similar in
other European countries where companies strive to improve their presence on
internet and integrate social media in their operations through their web site.

Figure 4. Use of social media, 2017 (% of enterprises

Source: Eurostat, national statistical offices

Regarding the use of social media, 47% of EU companies used some of the
social media in 2017, while in Serbia this percentage is much below the aver-
age – 35.7%. Other countries in the region are around the European average.
There are significant differences regarding the use of social media in European
countries - differences range from countries where more than 50% of com-
panies use social media (the Netherlands, Belgium, Scandinavian countries),
to those where this participation is below 30% (the Czech Republic, Slovakia,

186
Romania, Poland, Lithuania). It is interesting that regarding the use of social
media, the Republic of Macedonia stands out in the region what might not be
expected considering the unfavourable infrastructure and lower percentage of
enterprises with website and employment of ICT specialist. It could be said that
enterprises in the Republic of Macedonia wisely use social media: the largest
number of enterprises (38%) use social media to develop the enterprise image
or market products (source: Eurostat).
Use of cloud computing service is also a module in the surevey questionnaire.
In general, the use of cloud computing is considered an advanced level of ICT
use. As time progresses and more companies adopt cloud technlology, the ex-
pectations move from hype and confusion in the early years and migrate toward
broad acceptance as standards, best practices, and success stories emerge
(Kavis, 2014.). Therefore, the use of cloud computing is an important indica-
tor of e-business integration, i. e. enterprises willingness to adopt e-business
(on e-business concept for further details see Eurostat, Digital Economy and
Society Statistics).5

*Data refer to 2016 (the latest available data)

Figure 5. Use of cloud computing services, 2017 (% of enterprises)
Source: Eurostat, national statistical offices

Croatia is far ahead of other countries in the region regarding the use of cloud
computing services. The high value of this indicator for Croatia goes hand in
hand with other indicators of e-business integration which are also high for
Croatia, such as Use of Enterprise Resource Planning (ERP) and Use of Cus-
tomer Relationship Menagement – CRM. According to these indicators Croatia
is slightly behind Slovenia and far ahead of Serbia and Macedonia as well as of
a large number of other European countries. For Bosnia and Herzegovina and
Montenegro, data on e-business integration are not available.6

5 http://ec.europa.eu/eurostat/statistics-explained/index.php/E-business_integration
6 About E- business integration see on: http://ec.europa.eu/eurostat/statistics-explained/index.
php/E-business_integration

187
Regarding E - commerce, there is a larger number of indicators collected in the
survey for this module, however not all of them are available in publications
and statistical office databases or are not available for all countries in Eurostat
database. That is why here in the research the indicator Enterprises having
received orders via computer mediated networks was selected as e-commerce
indicator. This is an indicator which value can be found for all the countries in
the region and it is comparable regardless of already mentioned differences
of the indicator name. (“Orders received via internet” in Montenegro or just
“Received orders via computer networks” in the Republic of Macedonia). Some
other indicators that are collected by survey are Enterprises selling online (at
least 1% of turnover), Enterprises having orders via website or apps, and they
are also illustrative for e-commerce analysis, however, not all the countries in
the region publish them and comparisons cannot be made. Figure 6 shows
data for 2016 as this is the last year the indicator is available for all countries.

Figure 6. Enterprises having received orders via computer mediated networks,

2016 (% of enterprises)
Source: Eurostat, national statistical offices

However, it is not only the percentage of enterprises selling via internet that
matters, even more important is a turnover share obtained by e-commerce in
the total business turnover. Slovenia and Croatia are significantly ahead of the
countries in the region by the value of such achieved turnover. While the share
of such achieved turnover in the total turnover for EU – 28 was 18% in 2016,
for Slovenia it was 15% and Croatia 14%. As a comparison, for Serbia, this
percentage is rather low and in 2014 it amounted to only 6% of total turnover
(source: Eurostat database, also the latest data available), while the average at
the EU-28 in 2014 was 15% of the total turnover. It is important to note that 18%
of small and medium size enterprises in Croatia and 15% in Slovenia sell online
while EU average is 17%. For Montenegro, Bosnia and Herzegovina and the
Republic of Macedonia there are still no data available on electronic commerce
share in total commerce and there are no data available on online selling in the
total small and medium size enterprises turnover.

188
5. Results and Discussion
The assessment of the achieved level of ICT usage in enterprises cannot be
made only on the basis of the indicators observed here, however they are, to
a certain extent, indicative. There are differences in the achieved level of ICT
usage in the countries in the region. However, they are not too large. It could be
said that information infrastructure development in enterprises in the region is
at a satisfactory level with connectivity approximately or above the average for
EU, except for the Republic of Macedonia that generally has lower indicators
related to IT infrastructure than other countries in the region.
European Union member countries – Slovenia and Croatia are leading in
the implementation of modern advanced cloud computing technologies and
achieved e-commerce turnover. In addition, a large share of enterprises selling
their products via internet in Serbia and Montenegro indicates that enterprises
in these countries make significant efforts to develop e-commerce, probably
thus trying to overcome some other limitations and increase their market share.
It is noticeable that enterprises in the region make efforts to take an advantage
provided by information and communication technologies and improve their
business based on the existing infrastructure and within the existing opportuni-
ties, for example, more intensive use of social media (Macedonia) and employ-
ment of ICT specialists (Montenegro).
In comparison, one should be cautious because the values ​​of the indicators
vary from country to country depending on the differences on a national level in
the size and structure of enterprises, industrial specializations, level of devel-
opment of ICT infrastructure, and even the level of development and the style
of consumer culture to which businesses are adapting. Initial conditions of ICT
development have not been the same for all the countries in the region and
there are still many difficulties in economic conditions in countries that make the
progress of ICT usage difficult. In order to grasp a more complete picture of ICT
development in enterprises it is necessary to have a comprehensive analysis
of a larger number of indicators and analysis during time. Not all the indicators
are available for all the countries, some of them are still not collected and some
are being collected but not published yet.
However, all the countries in the region are dedicated to one goal and that is
information and communication technology development and improvement. In
recent years, since ICT statistics have been available and the awareness of the
need to raise ICT emerged, and Digital Agenda for Europe entered each coun-
try, countries in the region started to build their ICT development strategies.
European Union monitoring is also important, it points to shortcomings on this
path. One of the significant remarks to countries within European Union moni-
toring is the lack of financial stimulus. The countries themselves are aware of it
and lately they try to improve the development through investment.

189
So in July 2016, the Croatian government adopted “Strategy for Broadband
Development in the Republic of Croatia” for 2016 – 2020 in order to improve
IT infrastructure performances (European Commission, 2017(a), p. 4) which
plan necessary investment into electronic communications infrastructure and
associated facilities in mobile and fixed communication networks, in particular
investment in broadband access infrastructure. National short-term ICT strate-
gy of the Republic of Macedonia also perceives the importance of investment
in ICT infrastructure development, particularly for improving internet connection
and access to speed internet. Additional support will be provided by the Fund
for Innovation and Technology Development which was established in 2013. In-
vestment and Development Fund of Montenegro provides loan support for ICT
infrastructure improvement, development of new products and services in the
area and business development based on information technology; these are
exactly the aims defined by the Montenegro Information Society Development
Strategy. In addition to public investment, all countries expect significant private
investment, primarily foreign ones. Despite the already achieved high level of
all ICT indicators, Slovenia National Broadband Plan estimates that Euro 355
million should be invested to define broadband targets. The plan foresees pub-
lic funding, mostly European, amounting to € 72.5 million, and private funding
of € 292, 5 million (European Commission, 2017(b), p. 4).

6. Conclusions
After having analysed the indicators of ICT usage in enterprises, it has been
concluded that countries in the region are by the largest number of observed
indicators at or above the European average. Although there are differences in
ICT usage in enterprises in countries in the region, there is also an improve-
ment and achievements in the area. The efforts countries in the region make
in ICT development and investment will contribute to further ICT development
in countries. The advantages of this process will be numerous and will enable
inclusion of the countries into European Digital single market. The analysis has
showed that enterprises try to improve their business within the existing oppor-
tunities and based on the existing infrastructure. Countries that are not leaders
in ICT infrastructure development try to compensate it through intense use of
the existing capacities and achieve business advantages through the use of so-
cial media and employment of ICT specialists. The analysis pointed out to the
directions of further ICT development in the countries. For some countries this
will mean infrastructure improvement while for the others future lies in adopting
advanced technologies and e-commerce development but it is always about
the improvement of general performances in ICT use. Scientific theory will sup-
port this development through the improvement of the existing knowledge and
adopting new one. The fact that there not many scientific papers on ICT usage
in enterprises opens up many opportunities for authors. The area is a fertile
soil for analysis and comparisons, research of future development directions in
ICT usage in enterprises, the ways of overcoming the obstacles and achieving

190
the desired level of development in the area. A topic that might most likely be
of interest to authors is the contribution of ICT to business operations success
– contribution to productivity increase, competitiveness and improvement of
general performance on micro level and the entire economy on macro level
too. However, this is a new area and the next big step in an analysis which is
yet to come.

191
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 CHAPTER 11

In Search for Company Sustainable Value

Dejan Miljenović1

ABSTRACT

Inadequate company management can often be perceived as the main cause of severe
social, environmental and contemporary market issues. General perception is that com-
panies try to generate maximum profit at the expense of the society and the environment.
However, contributions of business sector to sustainable development issues became
relevant success factor during the last two decades. This is one of the important reasons
why sustainability and Corporate Social Responsibility (CSR) have become important
concepts in business management. Managers became aware that environmental and
social problems are not exclusively PR issues and that they represent opportunities that
may lead to future business and social growth. Sustainability and CSR strategies sig-
nificantly propel development and innovations of the companies, along with the positive
effects for society in general. In other words, it is a way to create economic value with
a sustainable adjective for the company and its stakeholders. In the past, concepts like
sustainability and CSR were often associated with environmental problems and efforts
to limit the negative impact on the environment. However, new market trends indicate
that there are much more than pure ecological concerns. Stakeholder groups are now
searching for information’s regarding sustainable value that company derives from its
CSR strategies. Sustainable value of a company is inevitably being shared in cooper-
ation with the stakeholders. The more companies spread their sustainable activities to
specific environmental or social impacts, than more added values should be created for
the society in general. The aim of this paper is to examine the process of distributing
sustainable value between the company and its stakeholders and presenting manage-
ment and development opportunities for analyzing this type of value in the future.

Key words: Sustainable value, Corporate Social Responsibility, Stakeholders,

Triple Bottom Line, Sustainability, Company

JEL classification: A13, M14, Q01

1. Introduction
There is a significant shift in a way that modern companies deliver their value
to the society. Although financial interests dominate, relevant global non-eco-
nomic changes affect the business process of value creation. First of all, there

1 Postdoctoral researcher, University of Rijeka, Faculty of Economics, Ivana Filipovića 4, 51 000

Rijeka, Croatia. Scientific affiliation: entrepreneurial economics. Phone: +385 51 355 136. E-mail:
dejan.miljenovic@efri.hr.

195
is more to a contemporary market than a traditional demand – supply relation.
There are significant modifications of relations between company and custom-
ers’ that have been expanded to different groups of interest. For example, be-
sides physical customers, who buy company products and services, there are
parties of interest who demand non-physical aspects of business to also be
ensured by the company. These are parties like governmental and non-govern-
mental institutions, activists or civil society groups, media, local communities,
public in general. They may insist on full transparency of the business process,
including all of its inputs and outputs, not only financial ones, but also non-fi-
nancial ones like environmental or social. Although these are non-financial as-
pects of doing business and they also have to be included in company eval-
uation. This is primarily due to concerns that relate to managing ecological or
social issues, which may arise as important business risks. Groups indicating
such risks are not only regular company shareholders but also groups related
to company by non-financial interests.
There are many groups being entitled to much more than pure shareholder val-
ue of the company. These groups are known as stakeholders, and they value
business contributions differently than the common shareholders. Because of
stakeholder’s diversity, they are oriented to different aspects of the company
business result, such as environmental or social ones. The social aspects of
doing business represent a level company includes in development of mod-
ern civil society. Crucial social aspects of doing business are represented by
the issues of human rights, child labor, decent work, employees’ (safety, edu-
cation and benefits), gender diversity and equal opportunity, customer health
and safety. Shareholders are also stakeholders, primarily interested in finan-
cial aspects of doing business. In the last two decades’ shareholders became
more aware of influences that non-financial business aspects have on their
shareholder value. Environmental aspects are a long term present issue of
modern business and society and manifest in a way company manages issues
of sustainable material, energy and water usage, the way its dealing with bio-
diversity issues, eliminating greenhouse gas emissions, effluences and waste
treatment. Therefore, stakeholders are extremely focused on the company Tri-
ple Bottom Line (TBL) as an integrated expression of financial, environmental
and social business results. TBL represents business sustainability evaluation
frame customized for the analysis of Corporate Social Responsibility (CSR).
Development of CSR business policies introduced a new paradigm of sustaina-
ble management in general. Friedman’s ˝exclusive profit˝ orientation broke un-
der a strong influence that non-financial risks have on company financial value.
Mistaken environmental and social risks appeared as an irreversible damage in
global business practices where a serious lack of responsible approach to such
risks took place. Exxon, British Petroleum and Volkswagen were not the only
companies that have lost multibillion profits and sustainable reputation due to
neglecting environmental issues. This was also the case with Nike, Sony and
some others in terms of inappropriate management of social risks. Because of
this, managers urgently wanted to evaluate business sustainability contributions

196
properly, not only for the company, but also for all the relevant stakeholders and
society in general. Moreover, the business leaders realized the importance of
cooperation with the stakeholders when managing aspects of TBL in order to
prevent mentioned risks. To ˝listen˝ the stakeholders became a relevant step
forward in company path to sustainable relationships with its environment. This
relationship, according to Porter and Kramer (2011) is a process of value shar-
ing. However, this paper research question goes a step forward by researching
the process of sharing sustainable value. When a company delivers its value
to its stakeholders based on sustainability performance, then this value has
sustainable characteristics. Aim of this paper is to present characteristics and
forms of sustainable value being brought to the stakeholders by the company.

2. Literature review
Importance of value sharing beyond company shareholders was recognized
by leading business experts and subjected to different types of analysis. Porter
and Kramer (2011) discussed shared value after 2007 (i.e. post-crisis) business
evaluation frame stating that ˝business has been criticized as a major cause
of social, environmental, and economic problems.˝ However, CSR strategies
dealing with this issues are developed almost 30 years to this point providing
organizational and management solutions to deal with business effects on envi-
ronment and society. One of the most important step forward was development
of the Triple Bottom Line approach (TBL), which in its core, respects financial,
environmental and social sustainability at the same level (Elkington, 1997). TBL
highlights benefits of integrating economic capital, human-social capital and
natural capital. These types of capital go beyond shareholder value and into
the area of non-financial business contributions. These contributions relate to
sustainable form of different environment and society issues. Mentioned is-
sues engage evaluation of company contributions to business related groups
other than shareholders. Therefore, the term stakeholders came to a focus of
modern managers as a set of interest and influential groups that are related to
one company operations on non-financial basis. According to Freeman (1984)
stakeholders demand adequate management reaction and improved organ-
izational response to environmental and social demands, especially in terms
of sustainability. Mitroff (1983) engages stakeholder theory defining that these
groups react to values organizations provide for them. However, research rec-
ognizes different types of sustainable value and shareholder value. Figge and
Hahn (2004) call it the Sustainable Value Added (SVA) by setting this formation
to different forms of company value added. Hart and Milstein (2003) provide a
framework where Sustainable Value is set between internal and external stake-
holders and present/future drivers for the value. This framework is later used
by Senge et al. (2010) to explain on individual and organizational contribu-
tions to sustainability. ˝The interest in sustainability and sustainable develop-
ment around the world today reflects an awakening that is occurring in many
forms… Continued growth of our take-make-waste patterns of consumption

197
and production will soon make this imbalance more acute.˝ (Senge 2009: 24).
Today, most of the leading business strategies rest on successful management
of sustainability issues. Sustainability performance can be defined as the ability
of an organization or firm to remain productive over time and hold on to its po-
tential for maintaining long-term profitability. Not only economic results should
be considered but also non-financial factors. Sustainability assessment is thus
a mainstream business activity that shows the link between the organization’s
strategy and commitment to a sustainable global economy (Kassem et al.,
2016). Therefore, Corporate Social Responsibility (CSR) is the other concept
that must be defined before the core subject of this paper, sustainable value,
can be addresses. In terms of stakeholder sustainability contemporary man-
agement puts up different questions, stating: What type of value do stakehold-
ers want? What information’s do they need? Should a company cooperate with
the stakeholders proactively? Answering these questions is not easy due to the
fact that every company has specific stakeholders and their influence depends
on different situations. One is certain, quoting the Jamstetji Tata: In a free en-
terprise, the community is not just another stakeholder in business, but is in fact
the very purpose of its existence. Business and stakeholders of the community
reciprocally share their values. This was recognized in CSR approach very
early (Backman, 1975; McGuire, 1963), however, tools for sustainable value
analysis weren’t developed at the time. In the same time models of financial
analysis did not evaluate sustainable risks in relation to environmental or social
issues. According to Graham and Bertels (2008) the sustainable value gener-
ated by CSR strategies has to be set in a suitable strategic framework. This
initiates development of stakeholder management. Sustainable value is also
called stakeholder value, because value distribution process in global econom-
ics is under influence of new technologies. Stakeholders have to be included in
this process and be able to evaluate elements of organizational sustainability
they relate to. Increasing relevance of stakeholder inclusion in business activi-
ties created companies improve their CSR strategies (Hediger, 2010). Although
sustainability approach based on stakeholders had its critics it gains an impor-
tant economic perspective, especially during recent crisis. The recent econom-
ic crisis revealed growing sustainability tensions related to economic growth on
one side and environmental and social sustainability on the other. Goal is to
reconcile global pursue of economic and sustainability.

3. Conception of analysis
There are different strands of thoughts regarding measuring the sustainabili-
ty performance of the modern companies. On the one hand, there are some
authors who claim that companies are only sustainable when the value creat-
ed surpasses the external damage they cause. On the other hand, there are
supporters of what is called ‘eco-efficiency’. They postulate that companies
should create as much value as possible per environmental impact. Unfortu-
nately, many of these approaches are either difficult to apply or, if they can
be applied, are of limited significance (Figge, Hahn, 2004). The framework of

198
eco-efficiency, for example, has some advantages but also limitations. The
biggest strength of the eco-efficiency framework is its simplicity. It contains a
manageable number of indicators which require data that is easily gathered.
This framework has nevertheless some important limitations, including: social
issues are not addressed; only a few measures for employees are included,
product sustainability is completely missing and a graphical representation of
the results is not recommended by this framework. All of these issues were im-
proved in research by Miljenović (2016) where sustainable value is empirically
tested and proved as an integrated measure of company sustainability. To per-
ceive sustainable value, it is important to take into account non-financial factors
and asses them with financial results. When companies operate they use three
basic types of resources: natural, human, social and financial resources. These
groups of resources are limited in supply. The way these resources are used
determines the welfare and the sustainability of one organization and society. It
is important that companies use these resources wisely since they play a key
role in guaranteeing the welfare and sustainability of our society. Performance
measurement should, therefore, not only cover the use of economic resources
but also the use of environmental and social resources (Figge et al. 2006). Sus-
tainability assessment can be carried out differently, depending on research
objectives. In this paper aim is to detect the elements of sustainable value in
relation to internal and external stakeholders and within the possible aspects/
content of sustainable value. This two approaches are explained below.

3.1. Sustainable value framework

Whenever the sources of sustainable value for each organization have to be
determined a sustainable value framework has to be set previously. Stakehold-
er diversity conditions different approaches in sustainable value identification.
Therefore, the methodology consists of different approaches. Hart and Milstein
(2003) developed a sustainable value framework that directly links the societal
challenges of global sustainability to the creation of shareholder value by the firm.
Sustainable Value framework represents strategic elements for managing busi-
ness sustainability including key business objectives, strategies and sustain-
ability practices. To set this framework company has to include stakeholders
in the process of identifying joint sustainable value. Most challenging part is
to predict future sustainability sources in different areas. Good prediction is
what usually marks successful leader and its company. Crucial examples are
inventions related to ecological efficiency, energy, internet and IT development,
with highest rates of growth in a globalized world. Today successful brands
base on new clean technologies that prevent pollution and on business pro-
cesses that include. Base of sustainability should be created in cooperation
with stakeholders because they are first source of impact from organizational
surroundings. Based on this framework value is shared between company and
its stakeholders becoming an external expression, i.e. the holistic impact of
one business. Companies more and more sell solutions to global social and
environmental issues.

199
Figure 1. The sustainable value framework
Source: Adapted from Hart, S. L., Milstein, M. B. (2003) ˝Creating sustainable value˝, Academy of
Management Executive, Vol. 17, No. 2, pp. 56-69.

The given framework turns into a specific sustainability portfolio for managing
sustainability value thru time. This portfolio includes (Hart 1997):
1. Clean Technology – improves ecological efficiency of production process
and contributes to general sustainable development objectives
2. Corporate vision based on sustainability issues – setting economic objec-
tives in a manner they support solving the unmet needs of stakeholders
or society in general
3. Pollution prevention – engaging policies of environmental protection on
all organizational levels and implementing environmental standards,
4. Product quality – enabling longer life cycles with less waste and main-
tenance.
By using this framework, a portfolio of sustainable value can be created for
each organization. Basic process is on identifying key stakeholders and to
manage relations between them and organizations successfully. In these con-
ditions sources of sustainable value can be determined.

200
Figure 2. Mapping the stakeholders based on their strengths and interest related to
sustainable value
Source: Adapted from Morris, J., Baddache, F. (2012) Back to Basics: How to Make Stakeholder
Engagement Meaningful for Your Company, Copenhagen: BSR – Business for Social Responsibility.

Objective of such methodology is to detect relations between stakeholders and

organizations that can generate joint sustainable value. This map, along with
before presented framework enables to manage sources of sustainable value
thru space and time.

3.2. Sustainability assessment

The underlying logic of sustainable value is actually the same as the logic that
investors use to evaluate an investment. When investors evaluate an invest-
ment, they compare the return on capital with the cost of capital. Since capital
does not really have a price, the investors must use an alternative approach
(Reeder, Colantonio, 2013). Therefore, investors compare the return on their
investment with the return on alternative investments. In this manner, they ac-
tually take the opportunity cost into account. Only an investment of which the
return exceeds this benchmark creates value. But companies do not only use
economic capital because they also engage significant social and environmen-
tal resources that should be taken into account. In order to assess corporate
sustainable performance, one should check if the use of a particular set of
resources creates value. This is not the case in common financial business per-
formance measurement. The use of all kinds of resources is expressed in mon-
etary terms, including the use of social and environmental resources. Figge
et. al. (2006) research sustainable value in monetary terms as a value created
or destroyed by a company through the use of a specific set of resources. By
using the same logic as financial markets, corporate sustainable performance
is actually translated into a language that is very understandable for managers
and investors. This is a sustainable value added approach that judges simulta-
neously the efficiency and the effectiveness of all three dimensions of sustain-
ability (economic, environmental and social). The measure indicates if the firm
reaches a certain threshold to contribute to sustainability. Furthermore, it also

201
indicates where and when the resources have to be allocated to realize their
highest sustainability contribution.
In this case methodology is set by two elements called the ‘if-question’ and the
‘where-question’. This is actually the same logic as the logic used by investors,
as described above. First, investors have to determine whether the return on
their investment exceeds the costs (if-question) and then, if the investment is
more attractive than other possible investments (where-question). The abso-
lute sustainable value added is the original value added of a company adjusted
for the external environmental and social costs and opportunity costs (figure 3,
upper left field) (Figge, Hahn, 2004).

Benefit > Cost?

(If-question)

considered non considered

considered

Absolute Sustainable Relative Sustainable

Value Added Value Added
Maximum benefit?
(Where-question)

not considered

Net or Green Value

Value Added
Added

Figure 3. If – and where – matrix

This approach judges simultaneously the efficiency and the effectiveness of

a certain set of resources. Efficiency refers to the ‘if-question’, namely: does
this particular set of resources contribute to sustainability and create value?
Effectiveness on the other hand, refers to the ‘where-question’, namely: is this
set of resources indeed more attractive than other possible sets? Sustainable
value added is, thus, a monetary approach to evaluate the sustainability per-
formance of companies in a way that is easily understandable for managers
and investors.
According to Figge et al. (2006), the procedure to assess corporate sustainabil-
ity performance using the sustainable value approach can be summarized into
five large domains that each consists of a few different steps.

202
 The five general domains are the following (presented by Figure 4):
1. Preparing for the assessment;
2. Data mining;
3. Calculating sustainable value;
4. Taking company size into account;
5. Interpreting and communicating results.

Efficiency Return
Amount used by Value
[€ per unit created with
the company contribution
of resource] the resources

CO2- ↗
Company 1,478 → 2,026,000,000 €
↘ -1,676,623,890 €
1,370,613 t
emissions ↘ Benchmark 2,701 → 3,702,623,890 € ↗
Figure 4. Determining sustainable value for one company within the benchmark

In the given example company with a use of 1,370,613 tons of CO2 emissions
destroys its possible sustainable value due to poor efficiency per unit of used
resources of 1,478. The rest of the benchmark has higher efficiency setting
higher returns with less resource and providing a sustainable impact. Data min-
ing is probably the most demanding part of given methodology because compa-
nies are still not transparent in publishing of non-financial information. To assess
the use of economic resources an opportunity cost approach is used. This means that
value is created when a resource is used more efficiently than through an alternative
use of the same resource. Conducting sustainability assessment based on en-
vironmental and social resources is more complicated approach. In this case,
environmental and social resources are approached in the same manner as the
economic resources. A company creates value when it uses the economic, en-
vironmental and social resources more efficiently than the benchmark. This is
elementary crucial for dimensioning the context for sustainable value research
and identification, which is proposed by this paper search objectives.

4. Documentation background and analysis

Research background rests on ADVANCE projections of sustainable value for
European companies. ADVANCE stands for Application and Dissemination of
Value-Based Eco-Ratings in Financial Markets and is an international project
supported by the LIFE Environment program. In this project the environmen-
tal performance of 65 European companies of the manufacturing sector is as-
sessed using the sustainable value approach (Figge et. al 2006.). ADVANCE
assesses the Sustainable Value for two scenarios. The past performance sce-
nario calculates the Sustainable Value for the years 2001, 2002 and 2003.

203
 In this scenario companies must use environmental resources more efficiently
then the EU countries in the same year. The future performance scenario uses
the expected 2010 benchmark efficiencies as benchmark. To create Sustaina-
ble Value in this scenario companies must use resources as efficiently as the
EU countries expect to use resources in 2010.
To illustrate the results of this analysis, the focus will be on the benchmark re-
sults within different countries. ADVANCE calculates the Return to Cost Ratio
(RCR) to assess the environmental performance of companies. This ratio indi-
cates how much more (or less) efficiently each company uses its environmental
resources. If the RCR is 2 then the company uses its environmental resources
twice as efficiently as the benchmark. For the years 2001, 2002 and 2003 the
performance of the company is benchmarked against the efficiency of the EU
countries of the same year and for the last column the company’s efficiency is
benchmarked against the expected EU efficiency in 2010. The results for se-
lected companies of automotive industries are shown in Table 1.

Company: BMW 2001 2002 2003 2003 > 2010

Sustainable
8,936,911,302 9,229,109,374 9,510,633,231 8,514,813,453
value (€)
RCR 4.3: 1 4.1: 1  3.9: 1  3: 1 

Company:
2001 2002 2003 2003 > 2010
DaimlerChrysler
Sustainable
30,077,701,600 31,896,158,886 29,876,257,351 26,133,559,478
value (€)
RCR 3.6: 1 3.7: 1 3.6: 1 2.7: 1

Company: Volvo 2001 2002 2003 2003 > 2010

Sustainable
3,163,639,310 3,341,355,994 3,396,583,146 2,882,359,807
value (€)
RCR 2.5: 1 2.5: 1 2.5: 1 2: 1

Company:
2001 2002 2003 2003 > 2010
Volkswagen
Sustainable
9,476,251,319 9,524,622,621 8,059,197,491 3,835,194,441
value (€)
RCR 1.6: 1 1.6: 1 1.5: 1 1.2: 1
Table 1. Advance results on sustainable value for automotive industry (benchmark)

Although ADVANCE Project relates to the period of 2001 – 2010 it is the only
holistic methodology of Sustainable Value calculation and therefore subjected
to analysis in this paper. According to the data DaimlerChrysler has the gener-
ated Sustainable Value among selected automotive companies. The BMW has

204
the highest RCR of 3: 1, meaning that it uses its environmental resources three
times more efficiently than rest of the benchmark. At the same time Volkswagen
has the lowest RCR within the benchmark, stating 1.2: 1. The projection of Sus-
tainable Value for all companies in the period of 2003 – 2010 ends with lower
values due to expectations that less resources will be used in the forthcom-
ing period due to technology advancement. It would be interesting to perceive
Volkswagen Sustainable Value affected by its Dieselgate affair in 2015. It would
certainly turn this value into negative; however, projections were not given for
the rest of the automotive industry in the period of 2009 - 2015.
The table below shows the ranking of all 65 companies taken into ADVANCE
Project. Companies are listed in alphabetical order. There are eight rankings
per company. There is a difference between a ranking based on absolute Sus-
tainable Value and relative Return to Cost Ratio (RCR). Both rankings are con-
ducted for the years 2001-2003 and for a future performance scenario i.e. the
year 2010. This is only existing calculation of Sustainable Value for EU coun-
tries until today.

RANKING
RANKING RCR
SUSTAINABLE VALUE
2003> 2003 >
No.  Company  2001  2002  2003  2001  2002  2003 
2010   2010  
1  ABB   7  9  8  6  12  13  12  9 
2  Acea   30  31  30  30  30  33  30  30 
3  AEM   49  45  46  40  60  58  57  57 
4  AEM Torino  31  33  32  32  44  41  41  42 
5  Agfa-Gevaert  19  19  18  17  14  12  9  13 
6  Airbus   9  8  7  7  1  1  1  3 
7  ASM   35  36  35  34  47  49  50  49 
8  AstraZeneca   8  7  9  5  17  18  18  14 
9  Atlas Copco   21  22  23  22  21  24  23  20 
10  BASF   52  54  52  54  35  35  35  35 
11  BG Group  42  46  40  42  41  43  39  40 
12  BMW   3  4  3  3  3  5  4  5 
13  BP   63  64  64  64  46  48  47  48 
14  Celanese   50  49  48  47  52  51  52  52 
15  Centrica   45  53  45  44  38  45  37  36 
Crown
16  29  30  31  29  45  46  46  45 
van Gelder  
17  DaimlerChrysler   1  1  1  1  7  6  7  8 
18  Degussa   47  48  49  50  36  38  38  39 
19  Edison   54  55  55  55  57  59  59  59 
Energias
20  56  57  57  58  61  60  60  60 
de Portugal  

205
 RANKING
RANKING RCR
SUSTAINABLE VALUE
2003 > 2003 >
No.  Company  2001  2002  2003  2001  2002  2003 
2010   2010  
21  Electrolux   18  18  19  19  23  22  22  21 
22  ENEL   61  62  59  59  54  54  45  47 
23  ENI   60  61  62  62  50  52  51  51 
24  ERG   44  43  53  52  58  63  62  61 
25  FIAT Group   41  47  41  48  32  39  33  34 
26  Fortum   55  56  56  56  56  57  58  58 
27  Gorenje   27  28  28  24  6  4  3  2 
Heidelberger
28  16  20  20  20  5  7  8  10 
Druckmaschinen 
29  Heineken Group   20  21  21  27  24  25  27  27 
30  Henkel   14  16  17  16  13  14  16  17 
31  Holmen   32  34  33  33  33  32  34  33 
Imperial
32  Chemical 33  32  34  35  29  30  31  32 
Industries  
33  Kemira   46  44  44  43  55  56  56  54 
34  MAN   N/A  13  13  11  N/A  15  14  12 
M-Real
35  37  38  38  38  37  37  42  41 
Corporation  
36  MVM   57  58  58  57  64  65  65  65 
37  NedCar   25  26  26  23  9  10  11  7 
38  Novonordisk   17  17  16  14  4  2  2  1 
39  Novozymes   26  27  27  25  22  21  21  22 
40  OMV   36  39  47  46  40  40  48  46 
41  Philips   5  5  5  4  8  8  6  6 
42  Pilkington   40  40  39  39  43  44  43  43 
43  Pirelli   23  24  24  31  26  28  28  29 
44  PSA   6  6  6  9  10  9  10  19 
45  Renault   11  11  10  18  18  20  20  25 
46  Repsol YPF  58  59  60  61  49  55  53  56 
47  Richter   28  29  29  28  25  26  24  28 
48  Robert Bosch   4  2  2  2  11  11  13  11 
49  Royal DSM   38  37  37  37  39  34  36  37 
50  SCA   34  35  36  36  31  31  32  31 
51  Scania  22  23  22  21  19  19  19  18 
52  Schering   15  15  15  13  2  3  5  4 
Scottish &
53  51  51  51  51  51  53  55  55 
Southern Energy  
54  Shell   64  65  65  65  48  47  49  50 
55  SKF   24  25  25  26  28  29  29  26 

206
 RANKING
RANKING RCR
SUSTAINABLE VALUE
2003 > 2003 >
No.  Company  2001  2002  2003  2001  2002  2003 
2010   2010  
56  Slovnaft   43  41  42  41  59  61  61  62 
57  STMicroelectronics  13  14  14  15  16  17  17  16 
58  Stora Enso  53  52  54  53  42  42  44  44 
59  Suez   62  63  63  63  53  50  54  53 
60  Unilever   10  10  11  12  27  27  26  23 
61  Union Fenosa   59  60  61  60  62  62  63  63 
62  Unipetrol   48  50  50  49  63  64  64  64 
63  UPM-Kymmene  39  42  43  45  34  36  40  38 
64  Volkswagen   2  3  4  8  20  23  25  24 
65  Volvo   12  12  12  10  15  16  15  15 
Table 2. Advance results on sustainable value for 65 EU companies

Sustainable Value reflects how much Sustainable Value is generated by the

company in absolute terms. It depends on company size and efficiency. Larger
companies tend to produce more Sustainable Value than smaller firms. This
can be due to volume economics where fewer resources provide more prod-
ucts. Some of the ranked companies are large technological companies and
known leaders of R&D sectors. To take this size effect into account companies
are also ranked according to their resource efficiency. This efficiency is termed
Return to Cost Ratio (RCR). Efficiency for a specific company can only be as-
sessed within belonging industry or a benchmark. Higher RCR indicates higher
Sustainable Value because resources are used in a better manner than the rest
of the benchmark.

5. Results and discussion

ADVANCE assesses the environmental performance of European companies
from six different manufacturing sectors, including: Automobile, Chemicals For-
estry & Paper, Oil & Gas, Pharmaceuticals and Utilities (ADVANCE Project
results 2006a). Sustainability performances of these sectors vary, depending
on used technologies, resources and innovations across time. Figure below
represents a very wide variability of performances within each sector.
ADVANCE data analysis indicates some very clear sector clusters in terms
of environmental impact and RCR indicators. Performances distinguish within
each sector confirming different Sustainable Value approach across one bench-
mark. The aim of the research was to reveal processes and forms in which
company delivers sustainable value to its stakeholders. It was established
that by representing the framework of sustainability value generated within
can be managed between organization and its environment. Sustainability as-
sessments are unfortunately very rare because financial analysis dominates.

207
ADVANCE methodology based on sustainable value framework and sustain-
able value assessment gives a unique example of sustainability assessment.
Results provided by a monetary value of company sustainable value and
backed up with an RCR rankings distinguish sustainable forms characterized
by varying levels of substitutability (different ratios of financial, environmental
and social capital). According to ADVANCE Project result RCR values are ex-
tremely low in Oil&Gas sector along with utilities that can include greenhouse
gas emissions, water and land pollutants. Industry of forestry, paper and chem-
icals also breaches in a few of RCR level due to the fact that they have a direct
environmental effect in terms of forest, landfill, water and air pollution. In terms
of research results these are crucial impacts representing contributions to Sus-
tainable Value. Existence of Sustainable Value is not questionable; however,
the way it is processed can be a matter of significance discussion. Results of
the ADVANCE Project are based on Figge and Hahn estimators of Sustainable
Value and cover crucial manufacturing sectors in the EU. Relative size, RCR
and benchmark specifications indicate that it is possible to detect non-financial
value that goes beyond shareholder value.

Figure 5. Environmental performance of European companies

in key manufacturing sectors
Source: ADVANCE Project results (2006b) available at http://www.advance-project.org/results/
sectorresults/index.html> [Accessed: January 5, 2018]

208
Research results can be observed through Sustainable Value portfolio. This
portfolio, similarly as the Sustainable Value framework consists of four basic
elements:
1. control of environmental and social risks (pollution and cost prevention);
2. implementation of innovations and clean/green-technologies;
3. coordination and data exchange with the stakeholders;
4. joint projects with local community.
To create stakeholder value, companies have to engage management for each
component and include it in its strategy. European companies are especially in-
volved, primarily by inclusive Corporate Social Responsibility strategies. Each
organization or a company has a wide range of sustainable business oppor-
tunities. Sustainability issues can be reduced to the Triple Bottom Line where
company manages its financial, environmental and social impacts. Sustainable
Value reflects Triple Bottom Line in a monetary value. Most companies focus
their time and attention on the short-term solutions tied to existing products
and stakeholder groups. However, sustainable value is a long-term indicator.
Therefore, a data projection of 2003 – 2010 is used. According to founders
of Sustainable Value framework (Hart and Milstein) incremental improvements
have to be associated with clean technology, and the largely underserved mar-
kets at the base of the economic pyramid. Future growth has to be profitable
not only for a company, but also for its stakeholders, which are environmen-
tally or socially interested. This long-term growth can be only determined as
Sustainable Value.

6. Conclusion
The values that companies distribute in modern global economics significantly
distinguish from those being generated during the 20th century. Technological
changes initiated by environmental concerns involved new types of stakehold-
ers into value creation processes. In this point value shared between compa-
nies and their stakeholders stops to be exclusively financial and enters en-
vironmental and social aspects that are of non-financial character. Above all
environmental and social issues related to business are directed to sustaina-
bility issues. Global problems of environmental devastation, social inequalities
and health impoverishment relate to worldwide business operations. However,
business sector has always been the generator of shared value. To recognize
its sustainable aspects each company should create own sustainable value
framework. This framework always consists of internal and external elements
related to specific company that may be the stimulators of sustainable value.
The focus of this paper was the assessment of sustainable value by differ-
ent approaches. Financial logic was used to assess the sustainability perfor-
mance of companies with regard to the use of economic, environmental and
social resources.

209
This approach is often more accessible for managers and investors. First step
is always on defining the concepts of sustainability and Corporate Social Re-
sponsibility among different stakeholders. Sustainable assessment was dis-
cussed with a focus on the Sustainable Value approach. To assess the sus-
tainability performance of companies, it is important not only to consider the
economic results but also to assess the non-financial factors; like the use of
environmental and social resources. Several approaches in the past failed be-
cause they engaged complicated evaluation of used environmental and social
resources. Sustainable Value framework and assessment evaluates environ-
mental and social resources in the same manner as the economic resources,
namely through an opportunity cost approach. Since it uses a financial logic
and is, therefore, easy to use for managers and investors, it could also con-
tribute to the further implementation of CSR practices in modern companies.
Important issue is shall all environmental and social effects of a company’s
activities be expressed in monetary terms. This research has unquestionably
proved that sustainable value exists in different forms, moreover, in terms of
future research it has also imposed the important question of applicable forms
and management strategies of sustainable value in the future.

210
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Elkington, J. (1997) Cannibals with Forks: The Triple Bottom Line of 21st Cen-
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212
 CHAPTER 12

The link between entrepreneurial learning and the use

of E-Visitors in the function of sustainable tourism
development (example of the study of
the peninsula of Čiovo)

Mirela Müller1, Brigitte Landmayer2

ABSTRACT

Learning about Entrepreneurship and Entrepreneurship represents an increasingly im-

portant aspect of the curriculum in the EU member states, especially as it is the main
factor in mastering the skills and use of E-Visitors for private landlords providing cater-
ing services for overnight stays. Entrepreneurial learning can have different goals and
results - from creating a new venture to the development of entrepreneurial traits, skills
and behaviors, which is extremely important both to capturing the skills of the E-visitor’s
IT system and for the sustainable development of Dalmatia’s tourism, especially in the
Čiovo peninsula; all in order to assist in the suppression of the gray economy of the
Republic of Croatia. Therefore, the aim of this paper is to conduct research to determine
the attitudes and opinions of private renters about the importance of participating in
training programs organized by the County Council of Okrug and incorporating the same
respondents to acquire entrepreneurial skills and acquire knowledge about the use of
E-Visitors. The subject of the research was private renters who participated in training
programs where they acquired entrepreneurial learning awareness, adopted certain lev-
els of digital competence and developed awareness of the role and significance of the
proper use of the E-Visitor system. The questionnaire was attended by 327 respondents
at the age of 21 to 57, where their views and opinions of local private renters were ex-
amined during the period from October 15 to December 1, 2017. The findings gained
insight into the importance of entrepreneurial learning in the framework of the Training
Program, which is important for adopting the general level of digital competence, as it
facilitates the use of E-Visitors and thereby suppresses the side economy in the region
of Dalmatia. Research can be an example of how third-year respondents can also be
catered for by providing catering services for overnight stays to further develop sustain-
able tourism development for the next generation.

Key words: entrepreneurial learning, digital competence, E-visitor information

system, sustainable development

JEL classification: L8

1 Asisitant Professor Dr. Mirela Müller, University of Osijek, Faculty of Humanties and Social
Sciences, Lorena Jägera 9, 31000 Osijek/Croatia, Mobile:+385/99/8327771, E-mail: mtolic@ffos.hr
2 Brigitte Landmayer, student, University of Mannheim, Department of Economics, Universität
Mannheim Schloss 68131, Phone: +49 621 181-1776, E-mail: blandmayer@web.de, Germany

213
1. Introduction
Studies on the future of work show that future employment biographies In-
creased switching between non-self-employed and self-employment and pe-
riods of training and unemployment can have. Workers should be in modern
working forms with flat operating hierarchies as entrepreneurs in the company
- so-called intrapreneurs (Esser, 2003). It follows: Entrepreneurial thinking and
action wins still important - throughout Europe. An entrepreneur is therefore a
person who is responsible for himself (Entrepreneur) or other (intrapreneur)
potentials active in the market seeks, recognizes and innovates on the basis
of new Combinations of production factors used economically (See Eickhoff,
2006, p. 51). If both entrepreneurs as well Intrapreneurs are understood as
entrepreneurs, is in this Contribution to Entrepreneurship may mean some-
thing to others Entrepreneurship, entrepreneurship or self-employment Culture
is called. Entrepreneurship Education is particularly special for Germany
great importance because here entrepreneurship and start-up activities only
lower than average (cf. Sternberg; Brixy; Schlapfner, 2006, p. 12; Wolfe, 2004)
and negative effects for Competitiveness, economic growth and employment
are afraid. On the one hand, they have as part of the Global Entrepreneurship
Monitor (GEM) respondents self-doubt whether they are over the skills need-
ed for entrepreneurship and Have experience3. With the proposed education
phases comprehensive Entrepreneurship Education concept is supposed to be
a way of achieving this Goal are shown. The concept is called curriculum - in
the sense from the result of a didactic reflection - understood. (see Jongebloed;
Twardy 1983, p. 176). Such a reflection applies to all didactic questions - target
group, intentions (goals), Contents, methods and teaching / learning success
control (see Böhm, 2000, P. 118) - a. This is intended to broaden the exist-
ing entrepreneurship Education approaches towards a coherent, educational
phases overall concept. The goals of the individual stages of education build on
each other, so with each education phase a targeted increase in competence
in the sense continuous professionalization (Aaker, 2010; Belch, 2015). In one
such spiral curriculum are subsequently in the individual Phases proven topics,
methods and teaching / learning success controls to match the target group
and the intentions. Hereby should create a coherent overall concept. Entrepre-
neurial learning can have different goals and results - from the creation of a new
venture to the development of entrepreneurial traits, skills and behaviors, which
is extremely important both to capturing the skills of the E-visitor’s IT system
and the sustainable development of tourism in Dalmatia. eVisitor - IT system
for registration and deregistration of tourists. The IT system for registration and
deregistration of tourists is an IT system that connects all tourism associations
of the Republic of Croatia. It will be accessible over the Internet without having
to download it to the computer. This system links and exchanges the most im-
portant tourism information provided by tourism associations and over 60,000

3 Vgl. Sternberg; Brixy; Schlapfner, 2006, S. 20. Die Kontrollbefragung von Experten zeigt
übrigens, dass diese Selbstzweifel nicht unbedingt berechtigt sind (vgl. ebenda, S. 21).

214
providers of accommodation services4. The individual tourist boards will have
an insight into all the information about the providers of accommodation ser-
vices and their properties as well as information about the number of tourists
in their area. An internet connection and a web browser suffice for the use of
the said IT system. For security reasons users will receive a login password
(Vidgen, R. Francis, D, Powell, P. & Woerndl, M., 2004) The system in which
information is collected and processed complies with all data protection regu-
lations. The Croatian Tourist Board, together with the tourism associations and
other stakeholders, has developed the IT system eVisitor. With this system one
wants to simplify the processes of the registration and deregistration of tourists
as well as the supervision of the payment of the tourist tax. In the Croatian
Official Gazette “Narodne novine” No. 126/15, the guideline on the collection
of guest data, on the form and content of the guest registration form has been
published. Thus, the said system is now the central point for the registration
and deregistration of guests, the payment of the tourist tax and the statistical
management of information on taxpayers and tourists. Taxpayers and tourist
boards are required to use the system from 1 January 2016 for the registration
and deregistration of guests. After that, alternative login and logout methods
will no longer be possible. What is the purpose of the IT system for the regis-
tration and deregistration of tourists? Collecting and processing information on
providers of accommodation and accommodation in the Republic of Croatia;
Registration and deregistration of guests by providers of accommodation ser-
vices via the Internet; Billing and control of the payment of the tourist tax; Data
processing and data analysis for statistical purposes and Cooperation between
public authorities.

4 https://www.evisitor.hr/eVisitorWiki/(X(1)S(f403b0qzidl35k1sxpkt44fd))/Javno.Web-API.ashx;

215
2. Literature review
Tabular presentation of literature analysis used for writing and text methodology
and discussion of work issues. 567

analytical skills5 adaptability6 reasoning ability7

Persistence assertiveness resilience
Observing the existence in Technology-market Chance Recognition
the industry knowledge competition
Learning-Techniques Au-
Disciplinarity Assertiveness-dynamics tonomy Procedures of
dynamics and agility
Dominance pursuit freight creation
Readiness to take decisions
Efficient work and personal Determination Develop-
with the joy of decision
initiative and introduction ment, Production Recog-
of new ones and distribu- uncertainty nition and Managing
tion of new goods from
Development-Development New sales markets
growth thresholds
of new ethical and normative
Finance-Flexibility
Procurement-markets
Extroversion Sensitivity and Frustration tolerance
Assessment capacity
empathy pursuit
Design Capability
Experimentation
Leadership Holistic Vision
Creative will Profitable
previous experience High level of intelligence In-
use Conscientiousness
ternal knowledge in (brand)
Inventiveness Identification
communication skills Information-Management
Innovation-Enthusiasm Communication skills
Control conviction
Integrity
protection right Conflict management
Contact ability and interest
Table 1. Tabular presentation of literature

5 Förderkreis Gründungs-Forschung. Good Practice in der Entrepreneurship- Ausbildung – Ver-

such eines internationalen Vergleichs. Studie für den FGF erstellt von Dr. Petra Moog. Bonn, 2005.
Frese, E. Unternehmensführung. Landsberg am Lech, 1987.
Gonon, Ph. Schlüsselqualifikationen. In: Wörterbuch Berufs- und Wirtschaftspädagogik, hrsg. von
F.-J. Kaiser und G. Pätzold. 2. Auflage, Bad Heilbrunn, 2006, Seite 427 f.
Harding, R. GEM Global Summary 2006, United Kingdom. O. O. 2007.
6 Esser, F. H.; Twardy, M. Entrepreneurship als didaktisches Problem einer Universität – auf-
gezeigt am Organisationsentwicklungskonzept WIS-EX« der Universität zu Köln. In: Entrepreneur-
ship in Forschung und Lehre: Festschrift für Klaus Anderseck, hrsg. von K. Walterscheid. Frankfurt
am Main, 2003, Seite 223 bis 239.
Jongebloed, H.-C.; Twardy, M. Strukturmodell Fachdidaktik Wirtschaftswissenschaften (SMFW).
In: Kompendium Fachdidaktik , hrsg. von M. Twardy. Düsseldorf, 1983, Seite 163-203
7 Böhm, W. Wörterbuch der Pädagogik. 15. Auflage, Stuttgart, 2000.
Eickhoff, M. Th. Früh den Unternehmergeist wecken. In: position – IHK-Magazin für Berufsbildung,
40. Jahrgang, 2007b, Heft 2, Seite 16.

216
3. Methodology and empirical data and analysis
Units included in the studio are self-employed renters-private at the age of 21-
57 years. Of these, only 26% of the total number of respondents participated
in the e-visitor management training program. A quantization methodology was
used in SPSS data processing. The questionnaire was attended by 327 re-
spondents at the age of 21 to 57, where their views and opinions of local pri-
vate renters were examined during the period from October 15 to December 1,
2017. Descriptive statistics were used to calculate the frequency, percentage,
Hi quadrat (χ2) and correlation coefficients (Cramer’s V (ρc) coefficient). In-
vestigate and identify the perceptions of private innovators on the importance
of communication-marketing strategy for tourism development as well as in-
vesting in adult education for the development of digital literacy on the use
of E-Visitors system. The findings gained insight into the importance of entre-
preneurial learning in the framework of the Education Program (Theme title in
Education Program: 1. New media as a customer service; 2. Increasing trust
through customer talk; 3. Possibility of service for users in new media in the
tourist sector; 4. Methods and techniques of hospitality on new media; 5. Man-
aging reputation in new media: fishing for comments; 6. A Strategic Approach
to Creating a Native Campaign; 7. Advertising Planning; 8. Designing and re-
alizing a native campaign and 9. The Steps to Implementing an E-Visiter Sys-
tem), which is important for adopting the general level of digital competence,
as it facilitates the use of E-Visitors and thereby suppresses the side economy
in the region of Dalmatia. The findings gained insight into the importance of
entrepreneurial learning in the framework of the Education Program, which is
important for adopting the general level of digital competence, as it facilitates
the use of E-Visitors and thereby suppresses the side economy in the region
of Dalmatia. Research can be an example of how third-year respondents can
also be catered for by providing catering services for overnight stays to further
develop sustainable tourism development for the next generation. Education
lasted one day in two sections. The first section was about getting familiar with
new technologies and the other on implementing ICT on practical examples of
using the E-Visitor System.

4. Results and discussion

Graph 1 shows statistical data on the importance of entrepreneurial learning in
the framework of the Education Program, which is important for the adoption of
the general level of digital competence, since it facilitates the use of E-Visitors
and thus eliminates the side economy in Dalmatia. Therefore, 78.64% (M=0.78.
SD=0.52) of respondents believe that an important entrepreneurial learning at
the expense of the Education Program that participants, or private renters, took
part because they adopted the general levels of digital competence that facili-
tate the use of E-Visitors System.

217
Chart 1. Statistical data on the importance of entrepreneurial learning in the framework
of the Training Program, which is important for the adoption of the general
level of digital competences because it facilitates the use of E-Visitors and
thus eliminates the side economy in Dalmatia.
Source: Authors

Graph 2 shows statistical data of respondents as being satisfied with the Okrug
Gornji Municipal Education Program which organized and will continue next
year. They, 84.25%, were satisfied that they would continue with the Program
and the following year. While 15.75% of them considered that they were not
satisfied and would not continue with the Education Program next year.

Chart 2. The statistical data of the respondents were satisfied with the Okrug Gornji
Municipal Education Program which organized and would continue next year.
Source: Authors

Chart 3. Shows this statistical results: 1. New media as a customer service

(9% M=0.45, SD=1.52); 2. Increasing trust through customer talk (7%, M=0.75,
SD=0.58); 3. Possibility of service for users in new media in the tourist sec-
tor (6%,M=0.69, SD=0.87)); 4. Methods and techniques of hospitality on new
media (12%, M=0.45, Sd=0.74); 5. Managing reputation in new media: fishing
for comments (6%,M=0.64, SD=0.48)); 6. A Strategic Approach to Creating
a Native Campaigne (11%, M=0.41, SD=0.85); 7. Advertising Planning (6%,
M=0.74, SD=0.57); 8. Designing and realizing a native campaign (9%, M=0.74,
SD=0.64)); 9. The Steps to Implementing an E-Visiter System (25%, M=0.41,
SD=0.41)

218
Chart 3. Static representation of the variables data that most of the participants in the
Education Program were able to acquire digital skills in digital competence to
work on the E-vist system.
Source: Authors
Legend: 1. New media as a customer service; 2. Increasing trust through customer talk; 3.
Possibility of service for users in new media in the tourist sector; 4. Methods and techniques of
hospitality on new media; 5. Managing reputation in new media: fishing for comments; 6. A Strategic
Approach to Creating a Native Campaign; 7. Advertising Planning; 8. Designing and realizing a
native campaign; 9. The Steps to Implementing an E-Visiter System.

In this part of the survey questionnaire, renters have their own perceptions
of investing in adult education through the E-Visitor Training System for the
development of skills through the aspect of significance of the development
of semi-tourism, increasing their own capital and for inclusion in the world of
tourism. Eight assertions were offered in total (Table 1-%)

219
 1 2 3 4 5
Variable N x² *df *p
% % % % %

For ease of
communication
between tourists and 9 10 11 20 50 100% 12.51 4 0.001
obligations towards
the Municipality

Opening and / or
joining entrepreneurial 10 12 18 18 42 100% 10.25 3 0.003
travel agencies

For the development

of digital literacy with .
14 14 13 25 34 100% 11.42 2
the goal of pragmatic 0.005
use of E-Visitors

To combat the
payment of unrequited
guests and to 24 12 13 11 40 100% 13.63 3 0.051
suppress the gray
economy

To monitor the EU
22 17 28 19 14 100% 13.61 3 0.021
trend

To facilitate the
collection of
19 24 25 16 16 100% 15.21 5 0.055
information related to
tourism demand

Table 2.
(Key: With each statement was used original-point Likert scale with anchors: 1 = strongly disagree,
2 = mostly disagree, 3 neither agree nor disagree, 4 = mostly disagree and 5 = completely I agree)

Table 2 shows that 50% of private renters (M = 0.37, SD = 0.37) most often as
the purpose of investing in adult education through the education program for
learning the use of the E-Visitors system are seen through a variable for easier
communication between tourists and municipalities, and 42% (M = 0.38, SD
= 0.41) believe that the purpose of learning e-Visitors was to increase capital
and attendance at EU 295 (M = 0.26, SD = 0.45) and third place is a varia-
ble to suppress the gray economy and prevent the payment of punishments
40% (M = 0.58, SD = 0.69), which means that private commentators think that
it is very important to know the use of E-Visitors system not only for report-
ing tourists and increasing private capital, but above all saw the way to the
inclusion of adults and thirds in the world of tourism and the development of

220
the digital economy. A statistically significant correlation (χ2 = 144,12, df = 3,
p <.05, Cramers V = .21) was obtained, where participants who participated in
training programs for the use of the E-Visitor system were more often aware of
the role and the significance of the communication-marketing skills strategies
for the development of semi-tourism in Okrug Gornji. Furthermore, testing of
statistical significance showed that most respondents considered a very impor-
tant investment in the E-Visitor Learning Training Program to reduce the rate of
gray economy at a statistically significant level of less than 1% (p≤0.01). Table
2 points out the necessity of development of communication-marketing strategy
and sets out the most important strategies that the respondents should acquire
in order to incorporate the trend into the trend of the world’s tourism world as
quickly as possible and thus by promoting the development of capital of the
same municipality (Kesić, 2003).

Variable 1% 2% 3% 4% 5% Total x² *df *p

segemntation 11 14 16 20 39 100% 11.412 3 0.005

positioning of
11 22 27 28 12 100% 16.45 2 0.004
tourist product

the differentiation 9 11 21 21 38 100% 16.521 1 0.003

Low cost and low

13 3 14 21 49 100% 09.21 4 0.005
prices
measuring and
predicting tourist 8 9 11 24 48 100% 14.13 5 0.005
market proposals
functional strategies
3 21 16 21 39 100% 13.51 2 0.002
and programs

Table 3. Respondents’ opinion on the type of communication-marketing strategy that

private renters should acquire
(Legend: The original scale of the Likert type with the anchors was used with each claim: 1 =
completely disagree, 2 = mostly disagree, 3 = disagree or disagree, 4 = mostly agree and 5 = fully
agree I agree)

Table 3 indicates the most important types of communication-marketing strat-

egies that renters should possess and develop. In the first place, it is very im-
portant to realize the significance of “measuring and predicting tourist market
proposals” (48%, M = 0.45, SD = 0.45), then “Low cost and low prices” (49%,
M = 0.71, SD = 0.68). A statistically significant correlation was obtained (χ2 =
139.21, df = 3, p <.05, Cramers V = .18) among those who sensitized HEAD
-TO HEAD POSITIONING significance: (Directly competing with competitors
with respect to the particular product properties on the same target part) and
DIFFERENTIAL POSITIONING (a quest for smaller market niches where there
is no strong competition for positioning your own product).

221
4. Conclusions
The acquired knowledge gives insight into the type of communication marketing
strategy that is important for private renters and facilitates the development of
semi-tourism in Dalmatia. Knowledge is produced, transmitted, accessed and
shared at the minimum cost. E-Visitor is a unique online information system
that provides insight into tourist traffic and accommodation capacities (com-
mercial and non-commercial) in Croatia. It generates statistical reports and
marketing indicators in real time (i.e length of stay, location, gender, age, coun-
try of residence, type of facility, destination, etc), which enables more efficient
monitoring of tourist traffic and revenues, allowing better control over the collec-
tion of accommodation fees creating a synergistic effect of all Croatian tourism
stakeholders and contributes to ensuring their competitiveness. The communi-
cation-marketing strategies have a major role in the development of tourism,
eycepally in the adults Education Program to the use E-Visitors System. To
use the E-Visitor system, it is necessary to develop digital literacy, and as a pre-
requisite of all this is a well-developed communication and marketing skill that
develops strategies for successful tourism development and more successful
renting of private catering services, mostly overnight stays. The information
and communication-marketings strategies have plays a significant role in im-
plementation in the tourismus industry in Dalmatia, Okrug Gornji and it can be
dimensioned starting from a study regarding the existing relationship between
this and the performance of Education Programm for the adults units in the
current economic contextand the E-visitors The study was conducted among
the most important renters and providing hotel service overnight stays units in
the peninsula Okrug Gornji and consisted of a questionnaire regarding the use
of the information and communication – marketing strategies technology for
the managerial and operational activity and its impact on obtained performance
and through ICT to establish tourist demand (Kotler, 2006). The current state is
such that technology it becomes smarter and smarter, and sales solutions are
required at every corner, and for a while they can testify to everything that has
a smart prefix. According to Kotler, marketing is required to bring the company
to a position in which will “survive” and even grow in a distinctive and diverse
environment interest groups and markets. Innovative circumstances that create
opportunities in the market are very important widely interpreted, as they do
not only extend to innovation in services and procedures, but also innovation in
management, distribution and communication, are of particular importance to
communication and marketing strategies for business and tourism as well as for
the development of digital competences regarding the use of E-Visitors system.
For this reason, Educational Programs for E-System Visitors and E-Marketing
are very important for adults who have very little or no digital literacy. All this
leads to the suppression of the gray economy, the EU_ trends of tourist demand,
the development of human capital, and the development of further skills in the
development of semi-tourism in Okrug Gornji. Of the communication-marketing
strategies, strategy has been extremely important: Low cost and low prices
and measuring and predicting tourist proposals. The acquired knowledge gives

222
insight into the type of communication marketing strategy that is important for
private renters and facilitates the development of semi-tourism in Dalmatia. Of
course we can talk about the placement priority inside marketing, but long-term
market potentials also means integration the market of procurement in a closed
market, the concept of the economy, without being talked about the importance
of purchasing marketing in the seller’s market conditions. The questionnaire
was attended by 327 respondents at the age of 21 to 57, where their views and
opinions of local private renters were examined during the period from Octo-
ber 15 to December 1, 2017. The findings gained insight into the importance
of entrepreneurial learning in the framework of the Training Program, which is
important for adopting the general level of digital competence, as it facilitates
the use of E-Visitors and thereby suppresses the side economy in the region of
Dalmatia. Research shows that the results, 78.64% of respondents believe that
an important entrepreneurial learning at the expense of the Education Program
that participants, or private renters, took part because they adopted the general
levels of digital competence that facilitate the use of E-Visitors System. They,
84.25%, were satisfied that they would continue with the Program and the fol-
lowing year. While 15.75% of them considered that they were not satisfied and
would not continue with the Education Program next year. Research can be an
example of how third-year respondents can also be catered for by providing
catering services for overnight stays to further develop sustainable tourism de-
velopment for the next generation.

223
REFERENCES

Böhm, W. (2000): Wörterbuch der Pädagogik. 15. Auflage, Stuttgart.

D. A. Aaker, D. McLoughlin (2010): Strategic Marketing Management, John

Wiley & Sons Ltd., West Sussex, England.

Eickhoff, M. Th. (2007): „Früh den Unternehmergeist wecken“. In: position –

IHK-Magazin für Berufsbildung, 40. Jahrgang, 2007b, Heft 2, Seite 16.

Esser, F. H.; Twardy, M. (2003): Entrepreneurship als didaktisches Problem

einer Universität – aufgezeigt am Organisationsentwicklungskonzept
WIS-EX« der Universität zu Köln. In: Entrepreneurship in Forschung
und Lehre: Festschrift für Klaus Anderseck, hrsg. von K. Walterscheid.
Frankfurt am Main, 2003, Seite 223 bis 239.

G. E. Belch, M. A. Belch (2015): Advertising and promotion, McGraw-Hill Edu-

cation, San Diego, California, SAD.

Jongebloed, H.-C.; Twardy, M. (1983): „Strukturmodell Fachdidaktik Wirtschafts-

wissenschaften“ (SMFW). In: Kompendium Fachdidaktik , hrsg. von M.
Twardy. Düsseldorf, 1983, Seite 163-203.

Nanda,R.,Khanna, P. (2011): “A historical overview of marketing strategies”,

International Journal of Multidisciplinary Research, Vol.1 Issue 7.

P. Kotler (2006): Osnove marketinga, MATE d.o.o., Zagreb.

T. Kesić (2003): Integrirana marketinška komunikacija, Zagreb.

Vidgen, R. Francis, D, Powell, P. & Woerndl, M., (2004): “Web service business
transformation.:collaborative commerce opportunities in SMEs,” Journal of En-
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Wolfe, K., Hsu, C. H. C., Kang, S. K., (2004): “Buyer characteristics among
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Internet sources:
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lion-This-Year-with-Retailers-Leading-Way/1012497/, available at 25.08.
2017

https://www.evisitor.hr/eVisitorWiki/(X(1)S(f403b0qzidl35k1sxpkt44fd))/Javno.
Web-API.ashx; [Accessed: October 3, 2017]

224
 CHAPTER 13

Entrepreneurs’ Readiness in Small and Medium-Sized

Companies to Face Challenges in Digital Business

Marino Golob1, Snježana Babić2

ABSTRACT

Under the influence of contemporary trends and economic and political integration in
entrepreneurial globalization, it is necessary to develop digital business in small and
medium-sized companies as an important prerequisite for survival in the global market.
Research conducted so far, as well as practical experience, indicate that entrepreneurs,
as the main driving force behind the abovementioned changes, have the need to acquire
additional knowledge, skills and abilities for conducting business of a certain quality in
the digital environment. This paper puts a special emphasis on Croatian small and me-
dium-sized entrepreneurs. Thus, a research was carried out to identify their readiness
to implement digital innovations in business. In relation to that, ways and frequency of
their education for digital business, along with their familiarity with certain knowledge
and skills to achieve success in the digital business were determined, as well as the
impact of competencies on their attitudes toward the use of ICT for business and the
intention to use new models of digital entrepreneurship. The results of the research may
contribute to practitioners, scientists and to all those who aim to increase the level of
digital transformation of the entire society and to create bigger profits.

Key words: entrepreneurs, digital business, competencies, small and

medium-sized companies, digital transformation

JEL classification: A20, O15, 033, O34, 035, 044, Q55

1. Introduction
The process of “digitalization” of small and medium-sized companies (SMEs)
and the development of the entrepreneurial capacity of European citizens
and organisations are key policy objectives of the European Union (e.g. the
Horizon 2020 Framework Program; Neirotti et al. (2017); The Entrepreneur-
ship 2020 Action Plan). Foroudi et al. (2017) have emphasised that the SMEs

1 PhD Candidate, Senior lecturer, Polytechnic of Rijeka, Business Department, Vukovarska 58,
51000 Rijeka, Croatia, Scientific affiliation: economy of entrepreneurship, marketing, investment
economics, Phone: +385 99 3670 518,E-mail: mgolob@veleri.hr.
2 PhD, Research associate, Senior lecturer, Polytechnic of Rijeka, Business Department, Vu-
kovarska 58, 51000 Rijeka, Croatia, Scientific affiliation: digital competencies, acceptance of
new technologies, human-computer interaction, e-learning, Phone: +385 91 544 66 15, E-mail:
sbabic@veleri.hr.

225
implementation of digital technology in their business enables them to respond
positively to customer needs, improve customer-side operations, increase their
efficiencies by reducing costs and achieve growth and innovation. Further-
more, the European Commission in its document “The EntreComp Framework”
(Bacigalupo et al., 2016) has emphasised entrepreneurship as a competence
and defined “digital entrepreneurship” as “entrepreneurship that involves the
use of new digital technologies (particularly social media, big data, mobile and
cloud solutions)”. According to Bacigalupo et al. (2016) the purpose of imple-
mentation of new digital technologies in small and medium enterprises may
be multiple e.g. to improve business operations and business intelligence, to
invent new business models, to engage with customers and stakeholders etc.
Garcia-Morales et al. (2017) have found that social media technologies (e.g.
wikis, blogs, microblogs, social networking sites, virtual worlds, and video shar-
ing sites, etc.) drive technological knowledge competencies and influence or-
ganizational performance and development of innovations. Also, the European
Commission in its document “e-Leadership Digital Skills for SMEs” has de-
fined “Digital Savvy” as one of the major components of “SMEs competence”,
and the research results of the e-leadership education show that “most SMEs
need leaders with very strong digital skills”. Implementation of Information and
Communication Technology (ICT) can be considered as an innovation in small
and medium enterprises (SMEs). Neirotti et al. (2017) have emphasised that
changes in the ICT paradigm raise the level of business complexity and bring
changes in competition levels, and have concluded that the adoption of ICT in
small and medium enterprises (SMEs) depends on the combined effect of size
and competitive environment.
The adoption of digital technologies by entrepreneurs of SMEs is a key fac-
tor for the successful development of digital entrepreneurship and economic
growth. Therefore, numerous authors have explored a wide number of factors
that affect the acceptance of digital technology by entrepreneurs. As an exam-
ple, Moghavvemi et al. (2015) have concluded that understanding the individu-
al, technological, and environmental factors can help in providing guidance on
the adoption and use of IT innovations by entrepreneurs of SMEs. Also, authors
emphasise that entrepreneurs who have the necessary resources and knowl-
edge for IS innovations will actively use an IS innovation. Ngoasong (2017) has
concluded that the influence of context (technological, institutional and local)
on digital entrepreneurship is mediated by entrepreneurial digital competen-
cies. Gangi (2018) has emphasized that entrepreneurship education requires a
comprehensive strategy which includes, for example, national innovation sys-
tem, investment in information and communication technology etc. Brusić et al.
(2017) have concluded that the development of innovative ICT knowledge and
skills (e.g. work with cloud computing) must begin in the early stages of primary
and secondary education.
The aim of this research was to identify readiness of Croatian small and medi-
um-sized entrepreneurs to implement digital innovations in business, especially
those from the Istria County and the Primorje-Gorski Kotar County.

226
In relation to that, ways and frequency of their education for digital business, their
familiarity with certain knowledge and skills to achieve success in the digital busi-
ness was determined, as well as the impact of competencies on their attitudes
toward the use of ICT for business and the intention to use new models of digital
entrepreneurship.
The rest of this paper is organized as follows. The following section contains
a discussion on the existing literature. Employed research methodology is de-
scribed in the third section. Fourth section presents the empirical results. Re-
search findings are presented and discussed in the fifth section. Concluding
remarks are offered in the last section.

2. Literature review
Digital entrepreneurship requires a new type of e-leader: “innovative disrupter”,
i.e. a person who, for example, “unravels the complexity of IT, increases ac-
cessibility to technology and is open to new ideas, with the ability to work with
peers” (Li et al., 2016). The entrepreneurs have three roles as follows (Dillen et
al., 2018): “technical-functional”, “managerial” and “entrepreneurial”/“strategic”.
Arendt (2008) emphasises that between SMEs and large corporations exists
the digital divide which broadens as digital technologies become more complex;
also, SMEs believe that THE costs of ICT are greater than the benefits of their
implementation into business processes. Based on the research results of SMEs
from Spain, Portugal, Poland and the USA, Arendt (2008) found that the “lack
of proper knowledge, education and skilled owner-managers and employees
within the enterprise” is the main barrier for the use of information and commu-
nication technology (ICT) and e-Business solutions in their business processes.
According to Ngoasong (2017), “entrepreneurial digital competencies” (EDCs)
refers to a combination of entrepreneurial and ICT or digital competencies. In
this context, according to the same author, entrepreneurial competencies include
entrepreneurial skills, knowledge and attitudes “required to search and acquire
new information, to identify and pursue entrepreneurial opportunities and to inno-
vate”, and ICT capabilities include technological capabilities (e.g. building tech-
nology infrastructure, business process integration and brand building).
Furthermore, the European Commission in its document “DigiComp” (Ferra-
ri, 2013) has emphasised that ICT competencies include “secure, critical and
accountable use and engagement of digital technologies for learning, at work
and participation in society” (e.g. information and literacy, communication and
collaboration, creation of digital content, security, problem solving, etc.). For ex-
ample, Neirotti et al. (2017) have defined three types of ICT-based capabilities
of SMEs: production management and administrative capabilities, production
innovation and market management, based on the use of ICT system (e.g.
Enterprise Resource Planning – ERP, CRM system, SCM system, collabora-
tive production planning, inventory management with external partners, product
data management, etc.).

227
According to the theory developed by Ajzen (1991), users’ attitudes to the be-
haviour have a direct impact on their behavioural intention to use new tech-
nologies and innovations. Furthermore, the model of technology acceptance
(Davis, 1989) is one of the most widely used models for adopting information
systems (IT) by users. Based on this model, users’ attitudes toward use of
the information system can be explained by the motivation of a user who is
influenced by the real features of the system in the organization. According to
TAM (Davis, 1989), perceived ease of use strongly and directly influences the
attitudes toward the use of innovative information and communication technol-
ogies by users. Both, Davis (1989) in TAM model and Venkatesh et al. (2003)
in their model Unified Theory of Acceptance and Use of Technology have con-
firmed that users’ intention of using IT directly affects the real use of IT.
Based on the theory of planned behaviour (TPB), Yaghoubi Farani et al. (2015)
have developed their model and found that a relationship between entrepre-
neurial knowledge and digital entrepreneurial intentions is mediated by the
attitudes toward digital entrepreneurship and perceived behavioural control.
Therefore, their research results confirm that attitudes toward digital entre-
preneurship is positively related to digital entrepreneurial intentions and that
entrepreneurial knowledge is positively related to attitudes toward digital en-
trepreneurship. Furthermore, results of the research based on UTAUT model,
Moghavvemi et al. (2016) indicates that perceived desirability and perceived
feasibility have significant effects on entrepreneurs’ intention to adopt and use
IS innovations. They have found strong effect of intention and facilitating condi-
tion on entrepreneurs’ behaviour (1,200 entrepreneurs in Malaysia).
Based on the existing literature, SMEs entrepreneurs have a lot of challenges
to face in the digital business, especially in the development of digital entre-
preneurial competencies which are required for the use of new digital business
models in the new era of global economy.

3. Methods
3.1. Participants
One hundred and eighteen small and medium-sized entrepreneurs from the
Istria County (59.3%) and the Primorje-Gorski Kotar County (40.7%) participat-
ed in this research. Among the participants, 43.2% of them were female and
56.8% were male.
The most frequent participants were between 35 and 54 years of age (64.4%).
The majority of small and medium-sized entrepreneurs (57%) had between 10
and 25 years of work experience in entrepreneurship. Furthermore, 44% of
participants had university qualifications, 36.4% had secondary school qual-
ifications and 17% had a two-year post-secondary school qualifications. Ac-
cording to the data presented in Figure 1, in most cases (90.1%), small and
medium-sized entrepreneurs are employing their smartphones for making and

228
receiving calls for the purpose of business, 87.9% for sending and receiving
emails, 78% for Web browsing, 74.5% for instant messaging (e.g. Viber, Whats
App), 69.5% for sending SMS messages, 56% for online account payment,
52.5% for accessing social networking sites, 42.6% for online education and
40.4% for online shopping.

Figure 1. Percentage of entrepreneurs of SMES using their smart phones to access

different applications for the purpose of business
Source: Authors’ calculation

With regard to the question: “How often do you attend workshops, courses,
seminars etc. for the purpose of developing your competencies in the busi-
ness environment?”, most small and medium enterprises answered “only once
a year” (52.4%) and “several times a year” (44%). These results are shown in

Figure 2. Percentage of SME entrepreneurs in relation to frequency of education for the

purpose of developing their competencies in business environment
Source: Authors’ calculation

229
Results of data analysis displayed in Figure 3 indicate that most of small and
medium-sized entrepreneurs acquire new entrepreneurial knowledge, skills
and abilities independently through print or digital resources (24.6%), courses
and/or workshops (22%), faculty (17%), secondary school (6.4%), while 15.3%
of respondents are not acquiring new entrepreneurial knowledge, skills and
abilities.

Figure 3. Percentage of entrepreneurs of SMES in relation to ways of acquiring new

entrepreneurial knowledge, skills and abilities
Source: Authors’ calculation

3.2. Instruments and Procedure

Based on document “The EntreComp Framework” (Bacigalupo et al., 2016),
document “e-Leadership Digital Skills for SMEs” (European Commission), doc-
ument “DigiCom” (Ferrari, 2013), Ngoasong (2017), Babić (2016) and Babić
and Bubaš (2015) a new questionnaire was developed, as were the following
five scales:
• entrepreneurial knowledge and skills refers to the ability to use knowl-
edge and skills (e.g. marketing, economics, management, internal and
external communication, project management) to implement entrepre-
neurial ideas.
• entrepreneurial digital competencies (EDCs) refers to the ability to use
ICT or digital skills in the entrepreneurial context.
• ICT knowledge and skills refers to the ability to use basic and advance
types of information and communication technology necessary for
business system.

230
 • Attitude(s) toward the use of ICT for business refers to the “positive or
negative perception” of entrepreneurs about the use of ICT or digital
technologies in the digital business environment (adapted Babić and
Bubaš, 2015).
• Intention to use new model(s) of digital entrepreneurship refers to the pre-
diction of the real use of digital technologies in business process (adapted
Venkatesh et al., 2003) .
The questionnaire was composed of 24 items related to participants’ demo-
graphics and 55 items assessing the knowledge and skills of small and me-
dium-sized entrepreneurs. Responses to the questionnaire items were modu-
lated on a five-point Likert scale (1-strongly disagree, 5–strongly agree). The
research was conducted by means of an online questionnaire (http://google.
com) in March and April 2018. Participation was voluntary and anonymous.
The processing of collected data was done by descriptive statistics, Pearson
correlation and multiple regressions analysis (stepwise). Internal consistency of
the scales was measured with Cronbach’s alpha coefficient. Results in Table 1
show that all of the scales had a satisfactory internal consistency (above 0.90).

Number Cronbach
Scale Mean SD
of items alpha
Entrepreneurial knowledge and skills 11 .94 38.14 10.07
Entrepreneurial digital knowledge and skills 11 .96 33.26 10.98
ICT knowledge and skills 24 .96 79.75 23.16
Attitude(s) toward the use of ICT for business 5 .93 20.26 4.55
Intention to use new model(s) of digital
3 .88 10.90 3.11
entrepreneurship
Table 1. Number of items, Cronbach’s alpha coefficients, Mean, Standard deviations
(SD) for scale(s) used in the research

4. Empirical data and analysis

The relationships (Pearson correlation coefficient) between the scales (mean
value) are presented in Table 2. As expected, it was found that entrepreneur-
ial digital knowledge and skills was strongly positively related to entrepreneuri-
al knowledge and skills (r=.85; p<0.00) and ICT knowledge and skills (r=.81;
p<0.00). Furthermore, results of Pearson correlation show that ICT knowledge
and skills correlated strongly and positively with intention to use new model(s)
of digital entrepreneurship (r=.61; p<0.00). Also, there was a strongly positive re-
lationship between attitude(s) toward the use of ICT for business and intention
to use new model(s) of digital entrepreneurship (r=.79; p<0.00).

231
Scale 1 2 3 4 5
1. Entrepreneurial knowledge and skills 1 .85** .69** .51** .51**
2. Entrepreneurial digital knowledge and skills .85** 1 .81** .52** .58**
3. ICT knowledge and skills .69** .81** 1 .54** .61**
4. Attitude(s) toward the use of ICT for
.51** .52** .54** 1 .79**
business
5. Intention to use new model(s) of digital
.51** .58** .61** .79** 1
entrepreneurship
Table 2. Pearson correlation coefficients (r) between scales used in the research
Note: **p<0.01; Source: Authors’ calculation

The results of the multiple regression analysis are presented in Table 3. Re-
sults show that entrepreneurial digital knowledge and skills (mean value of the
measurement scale) was predicted by entrepreneurs’ knowledge and skills
(β=0.56, p=0.00) and ICT knowledge and skills (β=0.43, p=0.00), resulting in
an explained variance of 82%. The regression model obtained is statistically
significant (F = 256.56, p <.001).

Variables Beta t Sig.

Entrepreneurial knowledge and skills .56 10.16 .00
ICT knowledge and skills .43 7.76 .00
Table 3. Results of regression analysis of entrepreneurial digital knowledge and skills
Note: p<0.01, Source: Authors’ calculation

Table 4 presents the results of the multiple regression analysis of intention to

use new model(s) of digital entrepreneurship (mean value). Results show that the
only significant predictor is the variable attitude(s) toward the use of ICT for
business (β=0.65, p=0.00) and this predictor can explain 68% of the variance
of intention to use new model(s) of digital entrepreneurship for small and medi-
um-sized entrepreneurs. The regression model obtained is statistically signifi-
cant (F = 59.55, p <.001).

Variables Beta t Sig.

Attitude(s) toward the use of ICT for business .65 9.99 .00

Table 4. Results Of Regression Analysis Of Intention To Use New Model(S)

Of Digital Entrepreneurship
Note: p<0.01; Source: Authors’ calculation

Furthermore, results (Table 5) show that the variable (mean value of the meas-
urement scale) ICT knowledge and skills (β=0.35, p=0.007) has the greatest
predictive power. This predictor can explain 33% of the variance of attitude(s)

232
toward the use of ICT for business by small and medium-sized entrepreneurs.
The regression model obtained is statistically significant (F = 18.89, p <.001).

Variables Beta t Sig.

ICT knowledge and skills .35 2.73 .007
Table 5. Results of regression analysis of attitude(s) toward the use of ICT for business
Note: p<0.01; Source: Authors’ calculation

4. Results and discussion

The findings of this research suggest that the entrepreneurial attitude toward
the use of ICT for business can explain 68% of the variance in relation to inten-
tion to use a new model of digital entrepreneurship by small and medium-sized
entrepreneurs. If entrepreneurs have mostly positive attitude toward the use of
ICT for business, they will have a higher level of intention to use ICT in their
business environment. These findings confirm the results of previous research
(Ajzen, 1991). In addition, entrepreneurial attitude was strongly positive in rela-
tion to entrepreneurial knowledge and skills and entrepreneurial digital knowl-
edge and skills. Results of research indicate that ICT knowledge and skills can
explain 33% of the variance of attitude toward the use of ICT for business by
small and medium-sized entrepreneurs.
The findings show that entrepreneurs who have a higher level of knowledge
and skills will have higher levels of positive attitude toward the use of ICT for
business. These findings confirm the results of previous research (Ajzen, 1991).
Also, the results of this research show that SME entrepreneurs who have a high-
er level of entrepreneurial knowledge and skills and ICT knowledge and skills
will have higher levels of entrepreneurial digital knowledge and skills. Those
predictors can explain 82% of the variance of entrepreneurial digital knowledge
and skills by SME entrepreneurs. The potential explanation for these results
is that digital entrepreneurship in small and medium enterprises is a relatively
new model in Croatian SMEs, thus entrepreneurs lack the knowledge and skills
needed for the use of a higher level of digital business process in the global
market. This research has several important theoretical and practical contribu-
tions. The findings of this research expand the knowledge on the acceptance
and adoption of digital entrepreneurship by SMEs and support the results of
earlier research. In addition, the results were confirmed by the entrepreneurial
knowledge and skills, entrepreneurial digital knowledge and skills, and intention
to use new model(s) of digital entrepreneurship and the correlation between
entrepreneurial knowledge and skills and ICT knowledge and skills.
This research can help policy makers and educational leaders, as well as all
those who want to increase the use of digital innovations by entrepreneurs of
SMEs, especially in the Istria County and the Primorje-Gorski Kotar County.
Since SMEs are of great value for economic growth, it is necessary to de-
velop such policies and strategies to help entrepreneurs develop their own

233
competencies for introducing digital innovations in their business (e.g. work-
shops, seminars, etc.). Entrepreneurs of SMEs do not have the same opportu-
nities for their development as large companies, therefore, SME entrepreneurs’
adoption of new business models that include the use of ICT is very slow. Fu-
ture research can involve a larger number of Croatian counties and may include
a larger number of factors related to adoption of innovations.

5. Conclusion
Based on theoretical and empirical research and authors’ practical experience,
3 following scales were developed in this research: entrepreneurial knowledge
and skills, entrepreneurial digital knowledge and skills and ICT knowledge and
skills. All of the scales in our questionnaire had a satisfactory internal consist-
ency (above 0.90).
The results of the empirical research have indicated that ICT knowledge and
skills is one of the main factors in influencing attitude(s) toward the use of ICT
for business. Furthermore, attitude(s) toward the use of ICT for business can
explain 68% of the variance of intention to use new models of digital entrepre-
neurship. Results have also shown that entrepreneurial knowledge and skills
and ICT knowledge and skills can explain 82% of the variance of entrepreneur-
ial digital knowledge and skills.
In this research, attitude(s) towards the use of ICT for business is the strongest
factor regarding the intention of using and the actual use of digital innovations in
entrepreneurship. However, if the entrepreneurs do not have sufficient entrepre-
neurial knowledge and ICT knowledge and skills, they will not be able to develop
a positive attitude toward the development of digital entrepreneurship and will
not use ICT in their business process. It will be useful to encourage entrepre-
neurs to be more interested in developing their ability to use ICT or digital skills
in the entrepreneurial context, which then will likely encourage them to develop
a positive perception of the value of digital entrepreneurship, which will conse-
quently result in positive attitude(s) toward ICT use in their business activities.
Research findings have shown that most small and medium-sized entrepre-
neurs in the Istria County and the Primorje-Gorski Kotar County in only one
year (52.4%) develop their competencies for business by attending workshops,
courses, seminars etc. Also, only 24.6% of entrepreneurs were using digital and
print resources to gain entrepreneurial knowledge, skills and abilities. These re-
sults indicate that most entrepreneurs of SMEs in the Istria County and the Pri-
morje-Gorski Kotar County do not develop their entrepreneurial competencies.
Based on the above-mentioned, it can be concluded that education of entrepre-
neurs for digital entrepreneurship is an important strategic decision for every
country, including Croatia. Finally, this research can contribute to a better un-
derstanding of attitudes of small and medium-sized entrepreneurs in the pro-
cess of adoption and implementation of innovative digital entrepreneurship in
the Istria and Primorje-Gorski Kotar counties.

234
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41, No. 1, pp.83-100CHAPTER 14

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 PART 4

DOCTORAL STUDENT WORKSHOP

 CHAPTER 14

From analytic to predictive digital performance

measurement - A new challenge for controlling

Neda Vitezić1, Antonija Petrlić2, Uwe Lebefromm3

ABSTRACT

Recently, digital technology enables companies to use a large amount of variety infor-
mation with high velocity which could be used in decision – making. The focus is on
«Big Data» which enables that vast amounts of transactions are quickly created from a
wide variety of sources. Due to data and information explosion we need more than ever
to develop analytical methods and models that will satisfy efficient business decision
making. Controlling as one of the important functions in any company that provides
analytical processing and creation of information for decision-making purposes is now
deeply affected by the challenges of digital technologies. Analytic or retrospective view
of performance measurement is changing to predictive or proactive. Big Data enables
controller’s to use more accurate data and develop forward-looking measures. The em-
phasis is on the prediction of future problems or identification of potential opportunities
which will lead to the growth of added value. As a result, the role of controllers as a busi-
ness partner needs to be further strengthened through its holistic analytical prospective
thinking that will contribute to more efficient decision making.
The aim of this research is to present possibilities for controlling on regard of digitally
oriented performance measurement and proactive role in decision making. The goal is
to develop a conceptual model of “digital proactive/prospective controlling” useful for
predictive analysis in any company using a range of “information literacy”. The research
is based on case study method followed by interviews with controllers and responsible
management in key positions of selected companies.

Key words: digitization, performance measurement, controlling, prediction,

JEL classification: M41

„This work has been fully supported by Croatian Science Foundation

under the project – A Model for Measuring the Efficiency of Public Health
Services (IP-2014-09-8235)“

1 Full Professor, University of Rijeka, Faculty of Economics, I. Filipovića 4, 51000 Rijeka,

Croatia. Scientific affiliation: entrepreneurship, accounting Phone: +385 51 355126. E-mail:
neda.vitezic@efri.hr.
2 Assistant, University of Rijeka, Faculty of Economics, I. Filipovića 4, 51000 Rijeka, Cro-
atia. Scientific affiliation. entrepreneurship,accounting, Phone: +385 51 355106. E-mail:
antonija.petrlic@efri.hr.
3 Ph.D. Student,.Education senior consultant,SAP Deutschland SE & Co.KG, E-mail:
uwe.lebefromm@sap.com.

239
1. Introduction
Today in the global world the number of information is enormously increas-
ing and therefore selection need to be made for decision making purposes.
Decisions are made on the basis of analytically processed data and the deci-
sion-making itself is a process of making choices from a number of alternatives
for the purpose of achieving desired results (Eisenfuhr, 2011). Respectively,
it is ‘the process of making choices by identifying a decision, gathering infor-
mation, and assessing alternative resolutions’ (Atstaja et al, 2017: 26). One of
the most important steps, on which the final decision depends mostly, is the
information gathering and analysis through adequate methods and models. In
today’s era of Big Data and more than ever digitalized technology companies
are enabled to use a large amount of variety information with high velocity.
Therefore, we need more than ever to develop analytical methods and models
that will enable efficient business decision making suitable for todays and fu-
ture fast-growing environment. Like in all other corporate functions (Vasarhelyi
et al., 2015) the Big Data effect has also deeply affected controlling, as one of
the most important functions for providing analytical processing and creation
of information for decision-making in any company. Hence, the performance
management shifts from reactive analytic to proactive and predictive analysis
(Kieninger et al., 2016). Together with that the role of the controller as a register,
navigator, innovator and business partner (Weber and Schäffer, 2014, Möller
et al., 2017) needs to be further strengthened through its holistic analytical
prospective thinking that will contribute to more efficient decision making. Only
companies that will consistently adapt to further trends and be able to predict
their outcomes will be capable of surviving and developing. Therefore, it is of
great importance that controllers have the ability of developing forward-looking
measures and make performance measurement adjustable to the digital area.
Big Data is the concept that enables them to do that more precisely than ever
before. Who is the person who will be in charge i.e. have the knowledge to
collect the required data and information from an unstructured pile of data, is
the question that arises due to the information role of controllers. Will that be
the task of the controller or the data scientist i.e. will the controller be forced to
become a data scientist to survive in an era of digital data and will the role of
controller in general be changed? How will that impact the performance mea-
surement system? All this questions arises from the growing need for prediction
of future problems and identification of potential opportunities which lead to the
growth of added value.
Therefore, the aim of this research is to present the possibilities for controlling
on regard of digitally oriented performance measurement and his proactive role
in decision making. More accurate, the goal was to develop a conceptual mod-
el of “digital proactive/prospective controlling” useful for predictive analysis in
any company using a range of “information literacy”. In order to develop the
model a literature review of current Big Data impact on controlling was carried
out, followed by interviews with controllers and responsible management in key

240
positions of selected Croatian companies. The primary findings are that the
controllers role will be party change due to the new digital era through constant
skills and knowledge improvements.

2. Digitalized controlling - a review of literature

During past few years the term ‘Big Data’ has been defined from many au-
thors. Boyd and Crowford (2012 :663) define it as a cultural, technological,
and scholarly phenomenon that rests on the interplay of technology, analy-
sis and mythology. Moffitt and Vasarhelyi (2013: 2) called it - the “pervasive
phenomenon of Big Data, while Gray and Alles (2015: 26) called it the “black
data”. According to Giri and Lone (2015) it is used as a term for a collection
of data sets so large and complex that it becomes almost impossible to pro-
cess them due to the multiplicity, heterogeneity and autonomy of the sources
of information characterizes with complex and evolving relationships, with con-
stantly growth. Zakir et al. (2015: 81) are defining it as ‘an important concept,
which is applied to data, which does not conform to the normal structure of the
traditional database’. Even there are many other definitions no one of them is
a universally accepted definition of Big Data. But according to most literature
Big Data is usually described as datasets that contain volumes of differently
structured, semi structured and unstructured data (Giri and Lone, 2015) mostly
characterized using 4 or 5 Vs: large volume of data, high velocity- analysis
of streaming data, high variety- analysis of different types of data structures,
information assets that demand cost- effective, innovative forms of information
processing that enable enhanced insight, decision making, and process auto-
mation (Gartner, 2016), veracity- data from different sources, data accuracy
and reliability, and value-examines the cost-benefit of collecting data (Zhang et
al., 2015, Merrit-Holmes, 2016). Within these characteristics what is important
for accountants, auditors and controllers are veracity and value, i.e. cost benefit
of collecting data.
The goal of accounting has always been to provide information to decision
makers (Capriotti, 2014), while the task of controlling was to use them i.e. ana-
lyze and present them to upper-level decision makers. Due to the new era of
technology controllers, who strive to the strategic, more future-facing role, must
go beyond traditional accounting data (Gray and Alles, 2015), or even beyond
current early stage of modern controlling data use. The sources of today’s data
are numerous. Whether they are internal, like archives and data storage, exter-
nal eg. public web, or both internal and external, like media, documents, busi-
ness apps, social media, sensor or machine log data (Kapow Software, 2013),
controllers must be capable to quickly identify which of them their company
should collect, how to analyze them, and what action plan the analysis de-
mands (Gray and Alles, 2015). Hence, the role of accounting as one of the in-
ternal data collectors will significantly decrease considering the total number of
external data that controlling will use in purpose of their analysis i.e. predictions.
Therefore, controlling will be forced to improve his skills and knowledge in order

241
to be able to help reach the efficiency and effectiveness of set goals. Although
there is not much research regarding Big Data and controlling jet, the question
on which most authors base their research is the future of controlling with re-
gard to his survival and future tasks and corporate role.
Kieninger et al. (2016:2) point out that ‘it is hardly surprising that the current
wave of digitalization, and Big Data in particular, will have a considerable influ-
ence on controlling of the future’. They see the changes as a huge impact on
methods, instruments, skills and organizations that will consequently redefine
the entire world of controlling, and therefore suggest an overall concept for ana-
lyzing, forecasting and optimizing all business activities using Big Data. Weichel
and Herrmann (2016) highlight that controllers can benefit of Big Data, espe-
cially the area of planning/forecasting, analysis, reporting and also the business
partner role, through the construction of analytical models. Mehanna (2014) on
the other hand highlights three main prerequisites that controllers need to fulfil
beside technical requirements to successfully implement monitoring, prediction
and prescriptive into their process: 1) strong governance through controlling, 2)
quantified and dynamic entrepreneurial models and 3) personal development
and change. Although so far controllers weren’t taught modern data analysis
technique, in order to fulfil their prediction role, authors referred to the essen-
tial role of various techniques, like ‘Data Fracking Strategy’, ‘Data Mining’ i.e.
business intelligence (BI), data analytics, predictive analytics, and prescriptive
analytics, as a condition for execution of the future role of controlling (Gentsch,
2003, Gray and Alles, 2015, Wang and Wang, 2015, Wang and Wang, 2016,
Appelbaum et al., 2017). Additionally, in 2013 The Chartered Global Manage-
ment Accountants (CGMA) has already reported that 51% of corporate leaders
consider Big Data and data mining as one of the top ten corporate priorities
fundamental for the data-driven era of business (CGMA, 2013). According to
that they point out that controllers have four potential roles: Data scientist, Data
manager, Data champion and Business partner (CGMA, 2014). There is no
doubt that the mentioned techniques are already needed in all companies to
make quick and accurate decisions. But the question that arises is if the use of
them should be in the department of the controller or the data scientist, and will
that mean that the data scientist as a more digitalized profession will reduce the
controller’s role in the future?
Al-Htaybat and von Alberti-Alhtaybat, (2017) through their interview based re-
search, came to the conclusion that controllers continue to play an important
role in their respective field by incorporating Big Data and its analytics. But what
is more important, regarding the role, skills and influence of data scientists, is
the conclusions that the years of training, acquired and tacit knowledge of an
controller aren’t replaceable, unless there is a data scientists with years of ed-
ucation and practice in controlling (Al-Htaybat and von Alberti-Alhtaybat, 2017).
The best data scientist are comfortable speaking the business language, but
people with all this skills are hardly to find, especially in a great demand that
we are facing together with the future digitalization (McAfee and Brynjolfsson,
2012). Therefore, even though data scientists are seen as new breed of mana-

242
gerial decision supporters, controllers are expected to break with their traditions
and collaborate with data scientists for mutual benefits (Osimitz Wieder et al.,
2018). Of course, controllers will have to improve their skills according to the
new techniques (Seufert and Treitz, 2017), but they will not have to become
a programmer and statistician i.e. date scientist and vice versa. Therefore, the
controlling that we knew and whose task was to support the decision making
on base of already existing data, is rapidly changing and becoming more de-
pendent to other corporate functions. Hence, todays controlling needs to start
from the problems or appearance that need to be solved i.e. predicted, and
accordingly to that find information that will give the answer for solving them
and keeping under control. Here comes the role of the data scientist – mining
and fracking of needed data, that controlling will finally transfer into information
and knowledge for decision making.

3. Research
For the purposes of creating conceptual model we first conducted an exstensive
desk research which involved the current situation relating to the knowledge of
Big Data and its use in controlling. Following the secondary and initial data col-
lection, structured interviews were then conducted with chairmen of controlling
departments in 20 middle and large companies from different branches. We
chose interview method because of more accurate and reliable received data.
A self-administered questionnaire (17 questions in total) was used to analyze
the controller’s:
• knowledge of Big Data concept
• recent usage of operative system
• the future role of controller
• advantage and disadvantage of Big Data implementation
Most of the interviewed companies had little knowledge of the Big Data concept
in generally. Only 25 per cent of the companies confirmed that they are fully
acquainted with the term ‘Big Data’, and only 12 per cent had no contact with
the therm. For example, some of the definitions they gave as their perception
of Big Data are:
“Big Data is a technology that allows the collection and processing of
large quantities of structured and unprocessed data in real time.”
“Processing large amounts of data.”
“The use of public networks and media data.”
“A large quantity of unrelated data that are raw material for the produc-
tion of information.”
“Relational databases.”
“Data processing software.”

243
The first definition is from one of the companies that were fully acquainted
with the term, while the other ones are from those who implied that they have
little knowledge of it. That is especially evident from the last definition, which in
no way corresponds to the definition Big Data. Hence, in generally they knew
the meaning of the concept. The half of the companies use Big Data and they
do it through web pages, internal archive, mobile sales application and other
web sources.
Most of the companies (75%) make forecasting and projections. The forecast-
ing is approximately on 3 years period and projection over 5 years with the use
of experience methods in most cases. A few of them (38%) use additionally sta-
tistical methods, like regression and time-series, and just 25 per cent of them
use more complex mathematical-statistical methods, like scenario methods
and Delphi method. Used operative systems are different (SAP, ORACEL, BW,
USALI,…) and partly satisfy their current needs in the controlling department.
According to the results, the controller’s role is definitively changed and their
knowledge should be more comprehensive including not only accounting and
finance knowledge but also skills of business analyst, econometric knowledge
as well as informatics. The professional profiles that will be required more than
ever due to the on-going orientation to prediction are controllers, business an-
alysts and data scientists. Accordingly, forecasting and projections will be the
future orientation of controller’s, but in the correspondence with the data scien-
tists, what confirmed all respondents.
Controller’s consider introducing Big Data into everyday’s job as an advantage
for their profession. Big Data will give them possibility to get new sources which
enable them to get the overall picture of analysed phenomena. Considering
possibility of volume, velocity and variety of data, interviewers expressed a kind
of risks in recognizing the “right things”! There is a fear of being irrational in
general because of rationality in detail. The comprehensive holistic approach
required wider knowledge and skills which goes beyond what is known today.

4. Digital Prospective Controlling – DPC model

The main role of controlling is to convert data into useful business decision–
making information. Thus the current wave of digitization, particularly Big Data
will have important influence on controlling in the future. In the 4th industrial
revolution, which characterized robotization and digitalization, information
collected by Big Data sources will definitively have impacts on various aspects
of controlling. Knowing relationship between manager and controller, which
today is very often described as “business partners”, leads to the first ques-
tion: Whether the relations between manager and controller will change due to
the digital environment? Probably requirements from the manger will be more
oriented to the risk avoidance and its prediction.

244
Figure 1. Future relationship between manager and controller
Source: Authors

For the purpose of achieving the stated objective controlling has always been
a process that has emerged as a result of common efforts of management
(individual or team) and controllers (Luković and Lebefromm, 2009). There-
fore, in today’s digital era i.e. the Era of Big Data, it is the manager’s job to
provide adequate digital support that will enable the largest use of Big Data
sources for the achievement of set goals. The controller as the business part-
ner on the other hand, needs to be capable to accurately predict and prospect
future phenomena. Controlling as process and needs to clarify, asses, evalu-
ate and make conclusions and suggestion due to selected statistical data and
other information.
The second question which arises is whether the controller’s orientation in in-
vestigation will be changed? The proactivity is already a characteristic of con-
troller, but with Big Data and risky environment predictive and prospective view
will be more pointed. Today’s analytic assessment of current situation based
on historical accounting data will be changed with predictive and prospective
planning system. Therefore, business analytics will be the critical area of their
professional work, which mean the use of big volume of data, selection of
key one’s, make proper interpretation and conclusions and give reasonable
propositions.

245
 Figure 2. Shift in controllers’ orientation
Source: Authors

The third question is put on controller’s methods. Whether they should be more
comprehensively oriented to statistics and mathematics? The interviews con-
firmed that the role of controller’s will be more oriented to forecasting and pro-
jections. Precisely, the skill method is still the most used but with shift to simple
statistical methods like regression, times-series and descriptive statistics.

Figure 3. Digital prospective controlling – DPC conceptual model

Source: Authors

The Manufacturig Execution Systems (MES), which is used for Optimized

Workflow in the production area, is not only the extended machine controller
or the extension of an Enterprise Resource Planning (ERP) system. In recent
years, the MES was widely seen as key figures generator for production. MES
is an element of planning and quality assurance, with the short-term by optimiz-
ing production efficiency and control can be increased considerably. A modern
production must be reactive in order to respond quickly to an ERP System. ERP

246
provides an integrated view of core business processes, often in real-time, using
common databases maintained by a database management system. They
also track business resources - cash, raw materials, production capacity - and
the status of business commitments: orders, purchase orders and payroll. The
applications that make up the system share data across various departments
(manufacturing, purchasing, sales, accounting, etc.) that provide the data.
Further, Short Interval Technology (SIT) is the concept, to monitor the business
processes in general and the production processes in detail, to be able for
fast reaction. On the technical side, the Information Technology (IT) system
enables for predictive maintenance. The system detects a technical problem in
future which enables the production control to plan the process for Enterprise
Asset Management. The technical components of SIT are sensors, actuators
and communication technologies like Radio Frequency Identification (RFID).
Cyber-physical systems are distributed networked production units - intelligent
objects that are linked in a web of data and services with each other and be
controlled autonomously. This involves the virtual image of the real world of
production and supplemented by information. This virtual image can be found
in the application system of the IT, making visible all possibilities of the manu-
facturing participants – human being and machines.
The use of Big Data, which can be characterized through different feature de-
scriptors, is associated with the role of Data Scientist. Big Data can lead to a
management revolution, if it is possible to generate the economic benefits of
Big Data. For this purpose, however further qualified personnel is necessary
that is specialized in terms of methodology in the analysis of data (Horváth et
al., 2015). A recent study by the Institute for Business Intelligence shows the
fundamental importance of Data Scientists. The role of the Data Scientist is
required for the conversion of data from Big Data in information. Only with the
obtained information the benefits of Big Data can be obtained at all. Therefore,
the development of appropriate skills and a sensible organizational integration
of the role of the Data Scientist is the critical point for a value-added contribu-
tion of Big Data. The role profile is described in the paper by Horvath, which
relies on the contribution of Davenport (Horváth et al., 2015).
Therefore, in the digital environment supported by innovative forms of informa-
tion processing, and according to the strategic and operative level of controlling,
the controllers role of selecting and processing data into key business deci-
sion-making information can be classified in following business analytic use:
• Descriptive analytics - What happened? i.e. PAST orientation
• (use of financial data and other quantitative data - Ratio analysis,
Clustering, Process mining…)
• Predictive analytics - What could happen? i.e. FUTURE orientation
• (use of forecast, probability models, statistical analysis and scoring models)

247
 • Prescriptive analytics - What should be done? i.e. FUTURE orientation
• (based on the descriptive and predictive analytics leads to optimization)
Hence, for the last two analytics the overall name that comes is prospective
analytics. Obviously the controller profile goes to the direction of combination
with data scientist although fundamentally remains business analyst. For sure
the controller need to have knowledge of informatics beside wider knowledge of
economy and econometrics, but because of mentioned characteristic and more
holistic approach to the concept of controlling in the future, term controlling is
not adequate- business analysis goes beyond controlling.

5. Conclusions
Controlling as one of the important functions in any company is now deeply
affected by the challenges of digital technologies. Big Data certainly enables
controller’s to use more accurate data and develop forward-looking measures.
Beside this advantage, there is also a need to define controller’s extended
knowledge of other interrelated disciplines- mathematics, econometrics and in-
formatics. Due to his future role in the business and requested skill the opens
the question of the controller/controlling terminology. Collaboration with data
scientist depends of the knowledge of both sides but the level of each others
knowledge is questionable. Hence, the good communication and future mutual
benefits depend on that level. Interviews confirmed that Big Data will have a
notably share in the future role of controlling i.e. for the projection and forecast-
ing in one word- prospective analytics. Theoretical research and practical view
of controlling gained by interviews enabled developing a new model named the
“Digital prospective controlling – DPC” which will be useful for predictive analy-
sis in any company using a range of “information literacy”.

248
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 CHAPTER 15

Digital Economy in Europe:

Evaluation of Countries’ Performances

Nela Milošević1, Marina Dobrota2, Sladjana Barjaktarović Rakočević3

ABSTRACT

The accelerated expansion of the Internet as a communication tool, the mobile internet,
and the social networks and commercial platforms, commonly observed as digitalisa-
tion, have greatly affected the functioning of the economy and with it also business-
es, public institutions, and individuals. This paper investigates how the on-going digital
transformation and Information and Communications Technologies (ICT) are manifest-
ing in the economies across Europe. We have collected the publically available data
on digital economy indicators in countries of European Union (EU) and used them to
perform a multivariate statistical analysis on countries’ performances. Using the Com-
posite I-distance Indicator (CIDI) methodology, we have created a multivariate indicator
that can serve as a measurement of digital economy performances. Digitalisation makes
information and knowledge easy to store, access, and modify, which links all parts of
social and economic life, but EU businesses are still not taking full advantage of these
advanced technologies or the innovative business models offered by digitalisation. The
state of the digitalisation of business and industry varies between EU countries and
regions. Each economy struggles to keep up with digitalisation in order to keep their
productivity and achievement on a high level. In this research, we used CIDI methodol-
ogy to evaluate and rank 28 countries in European Union (EU-28), based on their digital
performances. We made an in-depth comparative analysis of countries in Europe, pro-
viding each economy with information on where they currently stand in terms of digital
economy and what steps they need to undertake to improve and boost up their position
in an overall world of digitalisation.

Key words: Digital economy, Ranking, CIDI, Evaluation of Countries, EU Countries

JEL classification: C30, C49, O52, P51

* This paper is published in Proceedings of Rijeka Faculty of Economics-Journal of Economics

and Business/Zbornik Ekonomskog fakulteta u Rijeci: časopis za ekonomsku teoriju i praksu, Vol.
36, No.2, pp. 861-880, DOI: https://doi.org/https://doi.org/10.18045/zbefri.2018.2.861
1 Teaching assistant, University of Belgrade, Faculty of Organizational Sciences, Jove Ilića 154,
11000 Belgrade, Serbia. Scientific affiliation: management accounting, finance, banking. Phone:
+381 69 889 3303. E-mail: nela.milosevic@fon.bg.ac.rs.
2 Assistant professor, University of Belgrade, Faculty of Organizational Sciences, Jove Ilića 154,
11000 Belgrade, Serbia. Scientific affiliation: statistics, econometrics. Phone: +381 69 889 3386.
E-mail: dobrota.marina@fon.bg.ac.rs.
3 Associate professor, University of Belgrade, Faculty of Organizational Sciences, Jove Ilića 154,
11000 Belgrade, Serbia. Scientific affiliation: financial institutions, management accounting, finan-
cial markets. E-mail: sladjana@fon.bg.ac.rs.

253
1. Introduction
Economies across the world are greatly affected by the expansion of the World
Wide Web, the mobile internet, and the social networks and commercial plat-
forms. These are the common elements of the global term of digitalisation,
which nowadays makes an increasingly significant contribution to economic
growth. Digital technologies create an instrument that increasingly links all
parts of social and economic life, because digitalisation makes knowledge and
information easy to store, access, and modify (European Commission, 2018a).
The influence of digitalisation is spread out over businesses, public institutions,
and individuals, and, while it has brought many benefits, it has also generated
new problems and policy issues and challenges that policymakers are strug-
gling to resolve.
Digitalization in Europe has been considered as a significant driver of innova-
tion and economic growth, giving rise to new methods and techniques that raise
efficiency and productivity and create new products and services (European
Economic and Social Committee, 2017).
The European Economic and Social Committee have conducted study during
2016. and 2017. in order to realize benefits and possible issues of the process of
digitalization in European Union. This study focuses on the effects of digitalisa-
tion in the EU on traditional businesses and industries and the on-demand econ-
omy. It highlights the prospects and the obstacles that digitalisation creates, and
underline the challenges for overcoming these obstacles (European Economic
and Social Committee, 2017). What could be concluded from the study is that
the process of digitalisation will both create new and destroy old jobs. Com-
panies will create new methods and techniques that will lead to new jobs, but
consequently it will also replace old activities and enhance worker’s productivity
that will affect olds jobs (European Economic and Social Committee, 2017).
The digital transformation offers a broad set of opportunities for Europe, pre-
senting the enormous growth potential for business and society (Kamalipour
and Friedrichsen, 2017). It is identified by a synthesis of advanced technolo-
gies and the integration of digital systems and innovative business models, and
the creation of smart products and services (Matt, Hess and Benlian, 2015). It
enables a business to build on its strengths in advanced digital technologies
environment such as the big data, robotics, Internet of Things, 3D printing, and
artificial intelligence (European Commission, 2018a). EU businesses are taking
advantage of these advanced technologies to some extent, but the digitisa-
tion of industry diverge across areas, and between EU countries and regions.
There are disparities between companies of different sizes (Chen, Jaw and Wu,
2016). Thus, there is always room for improvement. The smart use of ICT by
enterprises and corporations in manufacturing and services is a crucial factor
for success in competitiveness, innovation, and economic growth (Nadeem et
al., 2018). Large companies are undoubtedly moving upwards to exploit the
advantages offered by digitalisation. Smaller companies are striving to follow

254
behind, but they still are at risk of being left out of digital supply chains (Europe-
an Commission, 2018a). World institutions are continually creating reports on
how to stimulate the digital transformation of European economies and enter-
prises, and proposing short and long-term strategy on digital entrepreneurship
to maximise its impact (Ardolino et al., 2017).
The importance of ICT has been recognized also by the World Economic Fo-
rum and it is included in its Global Competitiveness Index (GCI) that gas been
issued every year (World Economic Forum, 2018). This Index asses 137 coun-
tries and presents insight into drivers of their prosperity and growth, giving econ-
omy scorecard of those countries. GCI consists of 12 pillars, one of witch, pillar
9th refers to technology used and part of this pillar is assessment of ICT use in
every country. This driver – ICT use, measures Internet users, fixed-broadband
Internet subscriptions, Internet bandwith and mobile-broadband subscriptions.
This paper investigates how the on-going digital transformation and Informa-
tion and Communications Technologies (ICT) are manifesting in the economies
across Europe. We have collected the publically available data on digital econ-
omy indicators in countries of European Union (EU) and used them to perform
a multivariate statistical analysis on countries’ performances. The data include
an extensive evaluation of online platforms, EU data ownership, and digital
media content. The large volumes of data are nowadays generated, which pro-
vide significant opportunities for innovation, new business models, and smart
products and services (Wamba et al., 2017), and this is why it is crucial to in-
clude big data in the analysis (Huda et al., 2018). We also investigated digital
skills of the public. One must bear in mind that digital skills are also a significant
resource that influences the ability of EU businesses and economies to benefit
from the opportunities of digitalisation (O’Donnell, 2016).
Based on the collected data, and using the Composite I-distance Indicator
(CIDI) methodology (see Section 3), we have created a multivariate indica-
tor that can serve as a measurement of digital economy performances. We
used CIDI to evaluate and rank 28 countries in European Union (EU-28), based
on their digital performances. We made an in-depth comparative analysis of
countries in Europe, providing each economy with information on where they
currently stand in terms of digital economy and what steps they need to under-
take to improve and boost up their position in an overall world of digitalisation.
We also strived to propose country-specific policy recommendations based on
our findings.
This paper is organised as follows. The next section gives a comprehensive lit-
erature review. Section 3 describes the methodology used in the research and
Section 4 illustrates the empirical data used in the research. Section 5 repre-
sents the results of the survey, while Section 6 gives some concluding remarks.

255
2. Literature review
In recent years, companies have conducted a number of initiatives to analyse
new digital technologies in order to focus on their benefits. Digital transforma-
tion involves changes of key business operations, products, and processes. It
goes even further requiring new management concepts (Matt et al. 2015). We
argue that success of digital transformation depends on the development and
innovativeness of different economies across Europe.
Before the analysis of the differences between countries in terms of digitalisa-
tion, it is important to understand the term “digital”. McKinsey explains “digital”
throughout three key points. Digitalisation is about creating value; it relies on
process optimisation; and focuses on capabilities which support the whole busi-
ness idea (Schallmo and Williams, 2018b). With the fast development in the
field of ICT, countries, industries, and companies compete and create value in
completely new ways (Hyvönen, 2018). Development of digital capabilities and
resources is a consequence which is usually defined as digital transformation.
Selected definitions of the term “digital transformation” could be found in Schall-
mo and Williams (2018a).
The term New or Digital Economy is tightly linked to digital transformation. Fol-
lowing the work of Johansson et al. (2006), we use the phrase digital economy
in terms of “recent and still largely unrealised transformation of all sectors of
the economy by the general spread of ICT”. Moreover, digital economy is driv-
en by development and active usage of modern ICTs. Carlsson (2004) defines
the New or Digital Economy, pointing out that it is about dynamic efficiency.
Moreover, the author emphasises results in new activities and products rather
than higher productivity. Within the New or Digital Economy people face a new
level and form of connections among all market players; ideas are widespread,
and there is a high potential for creating heterogeneous and successful teams.
Company’s efficiency results in the long-term competitive position in the mar-
ket. A new challenge is how to measure the impact of ICT in both emerging and
well-developed countries. This paper is an attempt to define some of the digital
economy performances.
Some EU countries are more focused on innovations and digital business en-
vironments which means that those countries actively use all benefits of digi-
talisation. In the last three decades, research moves from innovation systems
to technological innovation system (Carlsson and Stankiewicz, 1991). Carlsson
and Stankiewicz (1991) point out the importance of a particular technology or
set of technologies, the networks through which people interact, and the insti-
tutional infrastructure. The purpose of technological innovation system is to
provide connections among various parts of the system (Carlsson and Stankie-
wicz, 1991). Nowadays, the key idea is to use all ICT advantages for creating
synergies, on the national, but also international level.
Not only that companies are aware of the pressure to innovate, but they spot
all opportunities to connect across the world with other companies in order to

256
improve their products and services, as well as to distinguish their strategies from
the key competitors. Till now, research has been limited in discovering and meas-
uring the results of all these innovations and ICT developments. On the country
level, researchers still measure national output in terms of GDP which leaves
us without a clear picture of the true effects of the technology (Degryse, 2016).
Billon et al. (2009) analysed countries’ differences in terms of ICT development
and found out that in well-developed countries digitalisation is explained by GDP,
service sector, education, and governmental effectiveness. Moreover, authors
pointed out that in developing countries population age and urban population are
positively associated with the ICT adoption. Additionally, the results showed that
in developing countries Internet costs are negatively associated with ICT adop-
tion. This might be a valuable finding which should give the direction for the future
activities in terms of ICT implementation in developing countries.
Moreover, Billon et al. (2010) found factors which explain the determinants
of ICT adoption in different groups of countries. A significant impact on digital
development for all country groups has only GDP. ICT and the Internet de-
crease production costs, enhance the creation and spread of new ideas, sup-
port knowledge, sharing, and improve R&D processes (Lucas, 1988; Romer,
1990; Aghion and Howitt, 1992; Meijers, 2014). The main conclusion is that ICT
is tightly linked to higher economic growth. Therefore, we argue that countries
should create strategies in order to use the potential that the digitalisation has.
Nadim et al. (2016) suggest that digitalisation includes new platforms that fa-
cilitate direct transactions, such as Airbnb and Uber, new activities such as
crowdsourcing, a growing category of the freelancers and ‘free’ media servic-
es, supported by ‘Big data’. Without ICT networking, learning, and innovation
processes, the development on a country level would not be possible. Having
the previous fact in mind, it is not strange that many researchers point out the
importance of ICT, using it as a key factor for growth (Yousefi, 2011; Meijers,
2014). The usage of new communication technologies like the Internet, social
networks, and commercial platforms improves knowledge and skills (Roller and
Waverman, 2001; Czernich et al., 2011) which lead to higher satisfaction and
better productivity.
The aim of Hanafizadeh et al. (2009) paper is to present a multi-stage method-
ology for constructing a composite index for measuring ICT infrastructure and
access. Without an attempt to analyse the digital divide between countries,
Hanafizadeh et al. (2009) emphasise that the most important factors in digi-
tal transformation are ICT infrastructure and access. Some studies focus on
measuring and quantifying the digital divide (Corrocher and Ordanini, 2002;
Bagchi, 2005; Vicente and Lopez, 2006). The multi-dimensional character of
the digital divide has led to the creation and analysis of different ICT indexes.
Therefore, we argue that there is a need for comprehensive research on indi-
cators which will create an index, good enough to show the current situation
and explain the ability of EU businesses and economies to benefit from all
opportunities of digitalisation.

257
The contribution of ICT investments in terms of technological infrastructure,
diffusion, and even usage has been in the focal point for many researchers and
practitioners. The importance of ICT is out of the question, but still, there is a
gap regarding measuring ICT development across countries. There are enor-
mous imbalances in terms of access inequalities of location, age, gender, ed-
ucation, and income (Heeks, 2010). Using the Composite I-distance Indicator
(CIDI) methodology, we have created a multivariate indicator that can serve as
a measurement of digital economy development. Moreover, the opportunity for
comparison between countries leads to better understanding of characteristics
of economies which benefit the most from the usage of ICT.
Regarding the literature on the digitalisation, there are two main streams of re-
search. The first is focused on the usage of digital technologies in both, macro
and micro levels. The second stream deals with the digital gap - the differences
in the development of digital technologies. Our analysis contributes to the sec-
ond stream of the research aiming to find the unique set of criteria for compar-
ing EU countries in terms of digitalisation level.
The Organization for Economic Cooperation and Development (OECD) has
developed several studies, whereby different countries are compared in terms
of access to ICTs and the Internet (OECD, 2000, 2001). The World Bank has
also issued research on the measurement of the digital division (a section of the
‘World Development Indicators’) that analyses different factors of digitalisation.
Usually, work on this topic is more informative rather than methodological (Cor-
rocher and Ordanini, 2002). Therefore, we firmly believe that CIDI methodology
has a potential to create an added value to the measurement of the digitalisa-
tion in EU countries.

3. Methodology
Composite I-distance Indicator (CIDI) is the methodology for calculating a mul-
tidimensional composite indicator. The general concept of CIDI is to calculate
the weights for a set of indicators that create a composite indicator; in this case,
it is a set of indicators that measure digitalisation of economies (see Section
4). The calculation of weights is based on the Pearson correlations between
the values of the I-distance (see section 3.1) and a set of input indicators. Cor-
relations are therefore altered appropriately to depict the importance of input
variables.

3.1. I-distance
The I-distance method is a metric distance in an n-dimensional space (Jeremic
et al., 2011, 2012; Dobrota, Jeremic and Markovic, 2012; Dobrota, Jeremić, et
al., 2015), initially defined by Ivanovic (Ivanovic, 1973; Ivanovic and Fanchette,
1973). The methodology was developed to rank entities according to specif-
ic indicators of interest. The main issue was how to use all of the indicators
to calculate a single indicator, which could be transformed into a rank, but to

258
overcome the common problem that a lot of different ranking methods possess,
and that can affect the measurements and evaluation: possible biases and sub-
jectivity. The procedure is the following (Jeremić et al., 2013; Seke et al., 2013;
Dobrota, Jeremić, et al., 2015; Išljamović et al., 2015):

where is the distance between the values of the

variable Xi for er and es, e.g. the discriminate effect, the standard deviation
of Xi , and rji.12...j - 1, is a partial coefficient of the correlation between Xi and Xj, (j<i)
(Ivanovic, 1973; Ivanović, 1977).
Sometimes negative coefficient of partial correlation can occur when it is not
possible to achieve the same direction of movement for all variables in all sets
(Dobrota, Jeremić, et al., 2015). To conquer this problem, it is suitable to use
the square I-distance, given as:

The I-distance is based on calculating the distances between the entities. It is

important to fix one entity up as the reference entity (Dobrota, Savic and Bula-
jic, 2015). The ranking of entities in the whole set is based on the calculated dis-
tance from the reference entity (Ivanovic, 1973; Ivanovic and Fanchette, 1973).

3.2.Composite I-distance Indicator

The purpose of the Composite I-distance Indicator (CIDI) is to create such a
ranking methodology which would be comparable and transparent as the broad
set of biased ranking methodologies defined by experts, but which would over-
come the problem of biases. The key to do so is to base a ranking methodology
on an I-distance measure. Thus we could create the methodology which was
unbiased as I-distance, but significantly more transparent and robust.
To create a CIDI, it is necessary to calculate the I-distance values based on a
set of input indicators. After that, the Pearson correlations between the I-dis-
tance values and input indicators are calculated. Correlations are used be-
cause of the particular characteristic of the I-distance method: it can present the
relevance of input indicators. The next step is to calculate the new weights for
each of the compounding indicators, which are based on the appropriate cor-
relations. Weights are formed by weighting the empirical correlations: values
of correlations are divided by the sum of correlations (Dobrota, Martic, et al.,

259
2015; Dobrota and Jeremic, 2016; Dobrota et al., 2016). The final sum equals
1, thus forming a novel appropriate weighting system:

(3)

where ri (i=1,…k) is a Pearson correlation between the i-th input variable and
I-distance value.

3.3. Uncertainty and sensitivity analysis

To measure the stability of the given ranking system, we have performed the
uncertainty and sensitivity analysis that is based on the relative contribution of
the indicators. The relative contribution of the indicators to each entity score can
provide useful information as to whether some indicators dominate the overall
scores (Saisana and D’Hombres, 2008; Dobrota et al., 2016). It is estimated
as a proportion of an indicator score multiplied by the appropriate weight with
regard to the overall entity score. Using the Monte Carlo simulation method, the
score results can be simulated a sufficient number of times, each time record-
ing the results. After that it is possible to count the ranks for all the entities, thus
measuring the amount of uncertainty of the ranking results.

4. Empirical research data

The data required to perform the study of how the digitalisation and digital
transformations are affecting the economies in Europe are collected from Eu-
rostat (ec.europa.eu/eurostat). All the data are public and available on a Eu-
rostat website. We extracted a set of 13 variables that measure the influence
that digitalisation has on the economies. Among them, eight variables are re-
lated to the enterprises (which could be defined as “E - economic”) and five
variables that are essentially related to households or individuals (which could
be labelled as “P - private”).
Eight indicators that are related to the enterprises (E1 to E8) are the following:
• E1 E-commerce Purchases of Enterprises – This indicator represents
enterprises that have ever made any purchase through computer-me-
diated networks. It is measured in a percentage of all the enterprises,
without financial sector (ten persons employed or more).
• E2 E-commerce Sales of Enterprises – The indicator represents the per-
centage of enterprises that are selling their products online (which cov-
ers at least 1% of their turnover). It includes all the enterprises, without
financial sector (ten persons employed or more).

260
 • E3 Internet Advertising of Enterprises – The percentage of enterprises
that use any social media for advertising over the internet. It covers all
enterprises, without financial sector (ten persons employed or more).
• E4 Value of E-Commerce Sales of Enterprises – The indicator that
measures enterprises’ total turnover from e-commerce. It is given as a
percentage of total turnover and includes all the enterprises, without fi-
nancial sector (ten persons employed or more).
• E5 Computer Internet Connections used by the Employees in Enterpris-
es – Indicator represents the persons employed using computers with
access to World Wide Web. It is measured as a percentage of total em-
ployment and covers all the enterprises, without financial sector (ten per-
sons employed or more).
• E6 Mobile Internet Connections used by the Employees in Enterprises
– This indicator counts persons employed in a company, which were
provided with a portable device that allows a mobile connection to the
internet for business use. It is measured as a percentage of total employ-
ment and covers all the enterprises, without financial sector (ten persons
employed or more).
• E7 Enterprises that have a Website – Percentage of enterprises that own
a website, enterprises without financial sector (ten persons employed or
more).
• E8 Enterprises that Employ ICT Specialists – Indicator is given as a per-
centage of enterprises, without financial sector (ten persons employed
or more).
Five indicators that are related to the households or individuals (P1 to P5) are
the following:
• P1 Level of Internet Access in Households - Indicator is given as a per-
centage of households with internet access.
• P2 Internet Use by Individuals – Percentage of all the individuals that
have accessed the internet in last three months.
• P3 Mobile Internet Access by Individuals – The percentage of individuals
that have used a mobile phone (or smartphone) to access the internet.
• P4 Use of Cloud Services by Individuals – The percentage of individuals
that have used internet storage space to save documents, pictures, mu-
sic, video or other files.
• P5 Internet Purchases by Individuals – Percentage of all the individuals
that have made an online purchase in the last three months.
All the indicators are normalised as they represent the percentage of all the
observed entities (enterprises, households, or individuals). The variables as
described above represent the input data for the CIDI indicator.

261
5. Results and discussion
The results of the CIDI analysis are given in Tables 1 and 2. Table 1 lists the set
of 13 indicators described in Section 4 and the set of their weights calculated
through the CIDI analysis.

CIDI
IndID Indicator
weight
E5 Computer Internet Connections used by the Employees in Enterprises 9.32%
P4 Use of Cloud Services by Individuals 8.84%
E6 Mobile Internet Connections used by the Employees in Enterprises 8.64%
P1 Level of Internet Access in Households 8.43%
P3 Mobile Internet Access by Individuals 8.16%
P2 Internet Use by Individuals 8.08%
P5 Internet Purchases by Individuals 8.06%
E1 E-commerce Purchases of Enterprises 7.82%
E7 Enterprises that have a Website 7.79%
E3 Internet Advertising of Enterprises 7.38%
E2 E-commerce Sales of Enterprises 6.98%
E8 Enterprises that Employ ICT Specialists 5.50%
E4 Value of E-Commerce Sales of Enterprises 4.99%
Table 1. Indicators that measure digitalisation in economies and their CIDI weights

The indicators in Table 1 are given in descending order according to weights

obtained by the CIDI methodology. Weights given in Table 1 reveal some in-
teresting findings. The most critical indicator in ranking countries according to
their digital performances is E5 Computer Internet Connections used by the
Employees in Enterprises with the largest weight of 9.32%. It is followed by P4
Use of Cloud Services by Individuals and E6 Mobile Internet Connections used
by the Employees in Enterprises. First interesting and perhaps a bit unexpect-
ed finding is that the indicators are later followed by four “private” indicators by
importance, and only at the end are remaining six “economic” indicators.
Second interesting and unexpected finding is regarding the importance of “fi-
nancial” and “non-financial” indicators. Indicators P5 Internet Purchases by In-
dividuals, E1 E-commerce Purchases of Enterprises, E2 E-commerce Sales of
Enterprises, and E4 Value of E-Commerce Sales of Enterprises could some-
what be defined as “financial” indicators. While P5 Internet Purchases by In-
dividuals and E1 E-commerce Purchases of Enterprises are relatively highly
rated among indicators (with their respective weights 8.06% and 7.82%), other
two are graded quite low. Indicator E4 Value of E-Commerce Sales of Enter-
prises has even obtained the lowest weight according to CIDI, only 5%. This
signals that when it comes to the positioning of the economies based on their
digital performances, the indicators that measure the internet use and the dig-
italisation access are more important than the amount of digital financial flow.
Table 2 presents the results of evaluation and ranking for 28 countries in Euro-
pean Union (EU-28), based on their digital performances.

262
 Country CIDI score CIDI rank
Denmark 66.62 1
Sweden 64.63 2
Netherlands 61.68 3
Finland 59.98 4
United Kingdom 58.48 5
Ireland 56.27 6
Luxembourg 54.13 7
Germany 53.71 8
Belgium 53.43 9
Austria 53.30 10
Spain 49.00 11
Malta 48.66 12
France 48.49 13
Czech Republic 47.26 14
Estonia 45.86 15
Slovenia 45.28 16
Cyprus 44.86 17
Slovakia 43.74 18
Lithuania 42.46 19
Hungary 42.08 20
Portugal 40.03 21
Latvia 39.50 22
Croatia 39.41 23
Italy 39.07 24
Poland 37.67 25
Greece 35.86 26
Romania 31.40 27
Bulgaria 30.21 28
Table 2. CIDI scores and CIDI ranks for EU-28

The results of CIDI methodology place Denmark on the top of the digital per-
formance ranking list. Denmark has accomplished the highest score of 66.62.
Denmark is a country that stands out also when it comes to the publically avail-
able ICT Development Index (IDI), published by International Telecommunica-
tion Union (www.itu.int), the index that measures information and communica-
tion development of countries. With IDI, Denmark takes the fourth position out
of the 176 analysed countries (ITU, 2017), and the first position if we extract
EU-28. Top five countries according to CIDI scores are Denmark, Sweden,
Netherlands, Finland, and United Kingdom. These countries also top IDI rank-
ing list, in a slightly revised order, except for Finland whose position is notably
lower with IDI. It is interesting to note that top five countries are not standing out

263
when it comes to some economic indicators, for example, trade surplus/deficit
or unemployment (Djogo and Stanisic, 2016).
Another index created by European Commission is the Digital Economy and
Society Index (DESI), a composite index that summarises relevant indicators
on Europe’s digital performance and tracks the evolution of EU member states
in digital competitiveness (European Commission, 2018b). The results of DESI
index are similar as to CIDI index. UK is rated slightly higher by CIDI (5th place)
than by DESI (7th place). CIDI index created in this survey differs from DESI
index because it is more thorough and profound. It holds the values of digitali-
sation indexes that we defined as “economic” (see Section 4).
Lowest five rated countries in EU-28 are Italy, Poland, Greece, Romania, and
Bulgaria, which have the lowest digital performances. A similar result is shown
in IDI ranking (ITU, 2017) and DESI ranking (European Commission, 2018b).
These countries have also shown the considerable economic disparities (Si-
mionescu, 2016) or a more substantial risk of poverty (Iwacewicz-Orłowska,
2016) compared to other EU-28 countries. Poland, for example, is better rated
by DESI (23rd place) than by CIDI (25th place).
Croatia is ranked 23rd by CIDI methodology according to countries digital perfor-
mances. It is ranked 24th by DESI methodology, and it has made progress in IDI
positions over the years. To understand the position of Croatia, we can extract
the values of individual indicators that create CIDI. For example, E5 Computer
Internet Connections used by the Employees in Enterprises is the most signifi-
cant indicator when it comes to forming a CIDI. In Croatia, 44% of total employ-
ees are using computers with access to World Wide Web, while in Denmark
this percentage is 73%, and in Sweden 75%, which is largest in the region. The
second indicator is P4 Use of Cloud Services by Individuals. In Croatia, only
16% of individuals have used internet storage space to save documents, pic-
tures, music, video, or other files. In Denmark, we have 69% of individuals, while
the largest percentage is in the UK, 78%. Croatia stands out with the indicator
E6 Mobile Internet Connections used by the Employees in Enterprises because
there are 28% of employees, which were provided with a portable device that
allows a mobile connection to the internet for business use. It is not a high per-
centage, but Croatia is ranked 6th by this single indicator among EU-28. Nev-
ertheless, Croatia is struggling to keep up. For example, a company Hrvatski
Telekom plans to invest more than 28 million euros in the digital transformation
strategies in the next three years (www.t.ht.hr). In the business report for 2017,
the company also stated that, in the mobile segment, the capacities of the 4G
network were increased by 34%, and mobile internet speed was increased by
38%, reaching 350 Mbit/s (www.t.ht.hr). The objective of digital transformation is
positioning of Hrvatski Telekom as the frontrunner in terms of user experience.
We also tested the stability of the CIDI indicator regarding the digital perfor-
mances of countries for EU-28 in 10 000 Monte Carlo simulations. The results
of the uncertainty and sensitivity analysis, as explained in Section 3.3., are
given in Table 3 and Figure 1.

264
265

Table 3. Uncertainty and sensitivity analysis of CIDI ranks

From Table 3, we can see that Denmark, Sweden, and the Netherlands are
in all 10 000 simulations precisely on their acquired positions, not making any
variations. Finland and UK have some slight deviations from their positions but
only in 0.41% of cases (41 out of 10 000). Variations in ranks are increasing
as we move down the ranking list. The largest variations could be found Ire-
land, France, Chech Republic, Cyprus, Latvia, and Croatia. For example, even
though Cyprus takes 17th position, its rank varies from 13 to 18. Initially 23rd,
Croatia varies from positions 21 to 25. Greece, Romania, and Bulgaria at the
end, again have stabile ranks. Graphical representation of uncertainty and sen-
sitivity analysis of CIDI ranks is given in Figure 1.

Figure 1. Graphical representation of uncertainty and sensitivity analysis of CIDI ranks

6. Conclusions
The main focus of his paper was to investigate how the digital transformation
affects the economies across Europe. We performed a statistical CIDI analysis
that allowed us to create a multivariate indicator that can serve as a meas-
urement of digital economy performances. We have collected the publically
available data on digital economy indicators in countries and created a CIDI to
evaluate and rank 28 countries in EU.
According to the results, we can see that Denmark tops the ranking list, followed
by Sweden and Netherlands. These countries stand out by their digital perfor-
mances from other EU countries. Lowest ranked countries are Romania and
Bulgaria. Croatia is struggling to find its place among other EU countries but still
has a long way to go, since it is in the lower half of a ranking list (23rd position).

266
Croatian enterprises are at the cutting edge of digital openness, surpassing
their regional counterparts, and they readily endorse digital technologies, es-
pecially in the area of e-commerce and cloud computing services. In spite
of this, the pace of their digital transformation is being slowed down by the
low-performance Internet infrastructure in the EU and the poor digital skills of
human capital.
The most critical indicators in ranking countries according to their digital per-
formances are E5 Computer Internet Connections used by the Employees in
Enterprises, P4 Use of Cloud Services by Individuals, and E6 Mobile Internet
Connections used by the Employees in Enterprises. We also found that “pri-
vate” indicators tend to stand out by importance in comparison to the “econom-
ic” indicators. The “non-financial” indicators, ones that measure the internet use
and the digitalisation access are more prominent than the “financial” indicators
that measure the financial flow of digitalisation.
Limitations of this study encompass the fact that we have used secondary data
that were publically available, while yet maybe some other significant indicators
could more soundly contribute to the ranking of countries based on their digital
performances. The study could be expanded to more countries other than EU
in the future.
This survey would particularly be interesting to those countries that strive to join
EU in the future. Researchers could use data from the survey to compare re-
sults from other countries to those of EU, and to propose recommendations and
expose digital opportunities, both for businesses and people. In due course,
this could lead those countries to get closer to prominent representatives of EU
countries in this field.
This survey may serve as a guide for future policy developments in the digi-
tal domain. For future research, it would be profoundly interesting to exclude
“private” indicators and to create CIDI only based on “economic” indicators. It
would be interesting to see what kind of changes in scores and ranks would
this variation cause. Another direction of future research can include the com-
parison of CIDI, IDI, and DESI index and to determine the difference in these
indexes results, weights, and above all the stability, which could provide a de-
tailed report of the state of digitalisation in Europe.

267
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 CHAPTER 16

Applying system dynamics

to model the world of cryptocurrency

Nikola Zornić1, Aleksandar Marković2, Milica Maričić3

ABSTRACT

The world of cryptocurrency has been seriously criticized, encouraged, and disallowed.
Regardless, its value and popularity has lately grown at the high rate. Among reasons
for this are buzz and hype created by the mass media; easy access to cryptocurrency
mining and exchange; and visible participation of retail and institutional investors. A lot of
tech-enabled individuals grabbed the opportunity to access this rising market and gain
some extra profit at low risk by cryptocurrency mining. Namely, cryptocurrency mining
implies adding transaction records to cryptocurrency’s public ledger of past transac-
tions. This paper presents a model of cryptocurrency space and factors influencing its
popularity and value. The model includes a wide range of variables and connections
among them. Based on that, the system dynamics approach is identified as most appro-
priate for better understanding the phenomenon.

Key words: cryptocurrency, system dynamics, model, factors

JEL classification: E42, E50, N10, O42, C61

1. Introduction
Cryptocurrencies can be defined as digital, computer currencies whose imple-
mentation stands on the principles of cryptography, both to validate the realized
transactions and to enlarge the currency in circulation (Cocco, Concas and
Marchesi, 2017). Cryptocurrencies use only cryptography to control transac-
tions, manage supply, and to prevent fraud. Each and every transaction has to
be confirmed, stored digitally and recorded in a block chain. Block chain can
be described as an accounting system. Nevertheless, it should be stated that
all cryptocurrencies differ in terms of software design, ownership structure, de-
cision rights, and degree of decentralization (Hsieh, Vergne and Wang, 2017).

1 Teaching Assistant, University of Belgrade, Faculty of Organizational Sciences, Jove Ilića 154,
11000 Belgrade, Serbia. Scientific affiliation: University of Belgrade, Faculty of Organizational
Sciences. Phone: +381 11 3950822. E-mail: nikola.zornic@fon.bg.ac.rs.
2 Full Professor, University of Belgrade, Faculty of Organizational Sciences, Jove Ilića 154, 11000
Belgrade, Serbia. Scientific affiliation: University of Belgrade, Faculty of Organizational Sciences.
Phone: +381 11 3950864. E-mail: markovic.aleksandar@fon.bg.ac.rs.
3 Teaching Assistant, University of Belgrade, Faculty of Organizational Sciences, Jove Ilića 154,
11000 Belgrade, Serbia. Scientific affiliation: University of Belgrade, Faculty of Organizational
Sciences. Phone: +381 11 3950822. E-mail: milica.maricic@fon.bg.ac.rs.

273
Mining is a necessary component of a cryptocurrency network which is carried
out by specialized hardware with a certain amount of computational power,
measured in hashes per second (Hayes, 2017). Mining activity is highly com-
petitive. Namely, the more mining power (resources) a miner applies, the more
chance he has to find new cryptocurrencies (Eyal and Sirer, 2014). Therefore,
the amount of mining increases the number of currencies in circulation.
It is presumed that the miners would act honestly and equally share the reward
for mining a certain cryptocurrency. Nevertheless, as mining carries monetary
value, it is a valuable target of attacks. Dishonest behaviour in mining is defined
as mining attack and implies various types of attacks to gain an unfair share
of the mining reward (Nayak et al., 2016). Well known mining attacks are self-
ish-mining (Eyal and Sirer, 2014) and eclipse attacks (Heilman et al., 2015).
To better understand the cryptocurrencies and the cryptocurrency market, the
evolution of digital currency from corporate-owned to truly decentralized plat-
form is shortly described in the following paragraphs. The concept of digital
currency started in the early stages of Internet. E-gold is believed to be the
first one. It was created in 1996 and by 2009 it grew to five million users. The
problems started when it became favourite in criminal circles and common
hackers’ target (Bloomberg, 2006). Several years later, the Moscow based
company started a form of digital currency which has all elements of a cryp-
tocurrency except decentralization. In 1998 it started WebMoney which offers
all kinds of financial services. Thanks to changes in its services, it prevented
usage for illegal activities. It is still operating and supporting various currencies,
including bitcoin.
Liberty Reserve was Costa-Rica-based centralized digital currency service. It
was founded in 2006 and shut down by United States government in 2013.
Reason for that was intensive service abuse for criminal activities like money
laundering, due to complete user anonymity. After the fall of Liberty Reserve,
Perfect Money emerged (founded in 2007). It is still operational and offers mul-
tiple currencies, including bitcoin. It remained operational thanks to the chang-
es in the policy. Namely, all accounts belonging to US citizens/residents/com-
panies were disabled (Perfect Money, 2013).
The most well-known and widely used cryptocurrency is bitcoin. At the same
time, this cryptocurrency has the greatest market valuation, usage, merchant
acceptance and popularity (Hayes, 2015). Bitcoin was introduced in 2009, as
the first decentralized digital currency platform, a currency which does not have
central authority to validate and settle transactions (Gandal and Halaburda,
2016). Therefore, the bitcoin is a sophisticated cryptocurrency (Barber et al.,
2012). It can be observed that the tendency in cryptocurrencies is towards
decentralisation.
In the following years other cryptocurrencies were launched. All cryptocurren-
cies that emerged after bitcoin are called altcoins. Some of the more popu-
lar altcoins nowadays are Litecoin (LTC), Ethereum (ETH), Peercoin (PPC),

274
Ripple (XRP), and Stellar Lumens (XLM). Namely, Ripple and Litecoin, have
notable market capitalisations of $441 m and $66 m, respectively (Cheah and
Fry, 2015).
As the Bitcoin is the most studied cryptocurrency, herein we will observe some
of its pros and cons. No cryptocurrency is beyond critique, and the same ac-
counts for Bitcoin. Barber et al. (2012) list several issues of the bitcoin such
as potential deflationary spiral, technical vulnerability, malware attacks, and
accidental loss of bitcoins. Yermack (2013) analyzed changes in bitcoin price
against fiat currencies and showed that its volatility undermines its usefulness
as currency. Moore and Christin (2013) empirically examined bitcoin exchange
risk using survival analysis and showed that the exchange is a valuable target
to thieves. Van Hout and Bingham (2014) pointed out that users transacting
on Deep Web sites are using Electrum (an anonymous Tor server) to access
a virtual wallet containing the Bitcoin. Although bitcoin was criticized, it has
admittedly witnessed enormous success and popularity since its creation due
to its added benefits. Some of the pros of bitcoin are anonymity, enhanced rev-
enue, decentralized nature, and use of proof-of-work mechanisms (Moore and
Christin, 2013).Nevertheless, the interest in trade with bitcoin has increased
slowly, but surely. Therefore, it is of growing importance to understand the fac-
tors which eventually influence its market value (Hayes, 2017). The question
which puzzles economists, IT experts, and the wider public is: Why do bitcoins
have value and what impacts their value? Originally, it was presumed that,
taking into account the construction of cryptocurrencies and the complex pro-
cess of digital “mining”, the prices of cryptocurrencies would be relatively stable
(Cheah and Fry, 2015).
This paper attempts to enlarge the current literature on cryptocurrency market
modelling. According to the literature review, few researches have been con-
ducted to model the cryptocurrency market. Therefore, we applied the system
dynamics approach for modelling cryptocurrency space using a wide range of
variables which potentially influence its popularity and value.
The remainder of the paper is organized as follows. A bibliometric analysis of
cryptocurrency-related content in scientific papers is presented in section 2,
including journals, research area and keywords used by authors. The following
Section will provide a brief overview on the research done on modelling the
cryptocurrency market. Section 4 firstly introduces the system dynamics ap-
proach and afterwards presents the model together with causal loops analyses.
Finally, conclusion and some notes for the future research are provided.

275
2. Bibliometric analysis
Cryptocurrencies have not been a topic of great interest for scientific papers
until recently. Namely, browsing the Clarivate Analytics Web of Science Social
Sciences Citation Index (SSCI) and Science Citation Index Expanded (SCIE)
with the topic “cryptocurrency” OR “bitcoin”, only 218 results were returned,
193 of them being published by the end of 2017 (Clarivate Analytics, 2018).
Additionally, it should be mentioned that the oldest paper covered by the anal-
ysis was published in 2012 and that in total of two papers were published in
the same year. Table 1 presents the number of papers published in the period
2012-2017. As it can be noticed, the number of papers on the two chosen top-
ics published per year is steadily increasing. Whereas the greatest increase
was between 2016 and 2017. Namely, 24 more papers were published in 2017.

Year Papers
2012 2
2013 8
2014 22
2015 37
2016 50
2017 74
Total 193
Table 1. Number of cryptocurrency-related papers in the period 2012-2017
Source: Authors

The observed 193 papers were published in 115 journals. In Table 2 we present
eight journals with at least five papers published in the period 2012-2017. The
top contributor is the PLoS One with 12 papers published, followed by New Sci-
entist with 11 published papers. This analysis can indicate that the papers relat-
ed to bitcoin and cryptocurrency are widely published and that there is still no
journal indexed on the SSCI and SCIE which is solely specialized on the topic.

Journal Papers
PLoS One 12
New Scientist 11
Communications of the ACM 9
Technology Review 7
Economics Letters 6
Computer 5
Finance Research Letters 5
IEEE Spectrum 5
Table 2. Journals accounting for at least five papers
Source: Authors

276
Analysing the research area in which cryptocurrency-related papers are pub-
lished, we can conclude that academia wrote the largest number of papers
in the fields of Business & Economics and Computer Science (Table 3). This
can be explained by cryptocurrency’s economic purport and inevitable usage
of modern computational technologies for doing anything related to crypto-
currency. It should also be noted that there have been 16 papers in the field
of Government & Law. The use and abuse of cryptocurrencies have attract-
ed the attention of governments. National bodies are, working in partnership
with blockchain firms to fight corruption and illegal activity (Campbell-Verduyn,
2017). Also, government agencies seem to be willing to consider a trade-off to
avoid outright prohibition in favour of pushing for a normalization of the bitcoin
market (Thiemann and Hütten, 2017). Therefore, the governments’ attitude
toward bitcoin and cryptocurrency and the imposed related regulations are a
prominent field of study.

Research area Papers

Business & Economics 57
Computer Science 48
Science & Technology - Other Topics 41
Government & Law 16
Engineering 14
Telecommunications 10
Table 3. Most popular research area
Source: Authors

Additionally, we analysed the keywords used in cryptocurrency-related papers.

Table 4 provides puzzling insights. The most commonly used keywords were
“Economics”, “Bitcoin”, and “Money”. However, they were used a small number
of times, only nine and eight times. There are several possible reasons for such
a result. First is that some journals do not have mandatory keywords. Second,
that bitcoin have been related to multiple topics, and finally that the same key-
words have been defined differently. For example, keyword “Market” can be
used within keywords “Artificial Financial Market”, “Market Simulation”, “Cryp-
tocurrency market”, which are all counted differently in our analysis.

Keyword Papers
Economics 9
Bitcoin 8
Money 8
Prices 6
Systems 6
Information 5
Model 5
Volatility 5
Table 4. Keywords used in cryptocurrency-related papers
Source: Authors
277
The presented bibliometric analysis indicates that the field of study of crypto-
currencies is developing, that journals indexed on SSCI and SCIE are recogniz-
ing the research conducted in the field, and that the issue of cryptocurrencies is
multidisciplinary, but mostly related to economics.

3. Brief overview on modelling the cryptocurrency market

According to the literature review, we observed that the research on model-
ling the cryptocurrency market is in two directions. One direction examines the
impact of individual variables on the cryptocurrency price, trade, and volatility.
While the other direction aims to model the whole cryptocurrency market and
its participants and interactions.
Kristoufek (2013) showed that the search queries and the bitcoin prices are
connected. On the other side, Glaser et al., (2014) examined whether user inte-
rest in cryptocurrencies at Wikipedia is due to interest in a new investment asset
or in the currencies themselves and results showed that most of the interest is
due to the asset aspect. Narayanan et al. (2016) showed that the supply and
demand by investors determine cryptocurrency value. Wang and Vergne (2017)
showed that the technology improvement needed to mine and perform block-c-
hain is the main predictor of price increases (as captured by weekly returns).
Very few researches have been conducted to model the cryptocurrency market.
Herein we present several papers which caught our attention. Namely, Hayes
(2015) aimed to model the cryptocurrency price using computational power in
GigaHashes per second, number of coins found per minute, the percentage
of coins that have been mined thus far compared to the total that can ever be
found, and number of calendar days from inception of the cryptocurrency.
Another interesting research is the one conducted by Bouoiyour & Selmi
(2014). They aimed to create a regression model of bitcoin value using mul-
tiple variables such as market price of gold, occurrences of the word “bitcoin”
in Google searches, and the velocity of bitcoin measured by transaction data.
Interestingly, most variables were not statistically significant. Their result might
indicate that many hypothesized and assumed variables might not eventually
have impact on the value of bitcoin (Hayes, 2015).
Recently, Cocco et al. (2017) presented an heterogenous agent model of the
Bitcoin market. Their model stand out as it includes different trading strategies,
an initial distribution of wealth following Pareto law, a realistic trading and price
clearing mechanism based on an order book, the increase with time of the to-
tal number of bitcoins due to mining, and the arrival of new traders interested
in bitcoins.

278
Hsieh, Vergne and Wang (2017) conducted a valuable research in which they
used multiple linear regression to model returns on cryptocurrencies using
variables of internal and external governance variables. Internal governance
variables were Owner control, Formal voting, and Centralized funding. While
external governance variables were Community governance, Negative publici-
ty, and Public interest.
As it can be observed most of the above-mentioned papers are related to bit-
coin and variables which impact its volatility. However, as the majority of cryp-
tocurrencies derive from bitcoin, they have the same set of built-in variables
which have an effect on their price and trade (Hayes, 2015). Meaning, the same
variables can be used to model their volatility and market. Therefore, the results
of the above-mentioned papers acted as foundation for some of the relations in
the proposed casual loop diagram of cryptocurrency value.

4. System Dynamics model of cryptocurrency value

System Dynamics Society (2018) defines system dynamics as “...a comput-

er-aided approach to policy analysis and design. It applies to dynamic prob-
lems arising in complex social, managerial, economic, or ecological systems
— literally any dynamic systems characterized by interdependence, mutual
interaction, information feedback, and circular causality”. System dynamic’s
basic tool is causal loop diagram, where elements are simply connected with
pointed arrows with connection polarity indicated. Connection polarity can be
either positive (+ or s meaning same direction) or negative (- or o meaning
opposite direction). The heart of the system dynamics approach is feedback
concept. Diagrams of loops of information feedback and circular causality are
tools for conceptualizing the structure of a complex system and for communi-
cating model-based insights. Important concept of the System Dynamics ap-
proach is loop polarity. If the tendency in the loop is to reinforce the initial action,
the loop is called a positive or reinforcing feedback loop; if the tendency is to
oppose the initial action, the loop is called a negative or balancing feedback
loop (System Dynamics Society, 2018). Positive feedback loops are related to
accelerated growth or fall, they are generally destabilizing the system. On the
other side, negative feedback loops are connected with stabilizing behaviour.
To our knowledge, system dynamics model regarding cryptocurrency has not
been presented in scientific paper. Therefore, we aim to build system dynamics
causal loop diagram, having in mind mineable cryptocurrency. The elements
which will be used in the proposed model are listed in Table 5. We are aware
that not all elements that can influence the cryptocurrency value are included.
The presented model can act as starting point for a more in-depth analysis of
the observed market. The causal loop diagram itself is presented on Figure 1.

279
 Model element Description
coin value value of specific cryptocurrency expressed in fiat currency
trading value value of cryptocurrency trade in specific time interval
trading volume volume of cryptocurrency trade in specific time interval
total coin supply cryptocurrency supply cap
current coin supply cryptocurrency mined up to date
initial mining costs costs of mining equipment
mining mining cryptocurrency using specific equipment
mining difficulty difficulty for mining new block
number of miners number of miners currently mining specific cryptocurrency
potential miners number of miners interested in mining specific cryptocurrency
search engine queries number of searches for specific cryptocurrency
media presence number of articles/reports regarding specific cryptocurrency

Table 5. Model elements described

Source: Authors

A few connections between elements will be explained here so as to facilitate

the interpretation of the relationships presented in Figure 1. For example, when
analysing the connection between number of miners and mining the higher
number of miners leads to a higher volume of mining, meaning that more coins
will be discovered. The presented relationship is positive and is marked with
plus on the diagram. On the other hand, if the current coin supply increases,
the gap in coin supply is going to decrease. Similarly, if the gap in coin supply
lowers, the coin value will rise (Barber et al., 2012). Those last two connections
are in the opposite direction, and they are marked with minus on the diagram.
Besides introducing the positive and negative relationships between model
elements, we will briefly present the negative feedback loop 5 (-FL5). In the
chosen feedback loop, the Number of miners influences initial mining costs,
whereas the change is in the same direction, as more miners leads to higher
initial mining costs (Warren, 2018). The rise of initial mining costs leads to re-
ducing the number of potential miners and number of miners. Mentioned three
elements are forming negative, balancing, feedback loop (FL). This and some
other feedback loops that define the behavior of the observed system are pre-
sented in Table 6. Namely, we have presented four negative and two positive
feedback loops. Feedback loops’ polarity is marked with “+” and “-” in front of
the feedback loop name.

280
281

Figure 1. Causal loop diagram of cryptocurrency market

Source: Autors
Feedback loop Description
coin value
Initial increase in coin value leads to increase of the number
potential miners of potential miners, followed by the increase in the number
+FL1
number of miners of miners, which then increases the media presence and
the coin value (Hayes, 2017).
media presence
Initial increase in coin value leads to increase of trading
coin value
value, which then attracts governments’ attention and who
-FL2 trading value then imposes restrictive measures in aim to control the
decentralized cryptocurrency market. Those measures
political restrictions
then reduce the cryptocurrency value (Parrish, 2018).
coin value Initial increase in coin value will cause increase in
number of potential miners, which leads to more search
potential miners engine queries, as they are acquiring information about
+FL3 search engine cryptocurrency mining, strategies, technology, and
queries prices. High interest in cryptocurrency leads to higher
media presence and then back to increased coin value
media presence (Kristoufek, 2013).
number of miners
If the number of miners increases, mining volume will
mining be higher, meaning that more coins will be discovered
(increase in current coin supply). Higher coin supply
-FL4 current coin supply
means smaller gap in coin supply, which leads to higher
gap in coin supply mining difficulty and that leads to decrease in number of
miners (Kristoufek, 2015).
mining difficulty
In the past, it was worthwhile to mine bitcoin on a
standard home computer, which is no longer case
(Gandal and Halaburda, 2016). Warren (2018) showed
initial mining costs
that with expansion of the cryptocurrency mining world of
-FL5 potential miners gamers encountered with high prices of GPUs (Graphics
Processing Unit) and even shortages. The same applies
number of miners
to potential miners interested in stepping up and acquiring
the mining equipment. These conditions might discourage
potential miners. Therefore, this feedback loop is negative.
coin value
If coin value increases, the number of potential miners
potential miners will also increase, leading to higher number of miners
number of miners and higher mining volume. Coin supply, trading volume
and trading value will also increase. This growth of
mining cryptocurrency will attract governments’ attention and
-FL6
current coin supply new attempts of controlling the market. Feedback loop
closes with influence in opposite direction from political
trading volume restrictions to coin value, which means that initial increase
trading value in coin value will lead to changing the direction of its own
influence – do decrease in value.
political restrictions
Table 6. Structure of feedback loops
Source: Authors

282
3. Conclusion
Bitcoin and other cryptocurrency markets have been under-explored academ-
ically in spite their rising popularity (Cheah and Fry, 2015). The scientific com-
munity has been fairly sceptic to embrace the field of cryptocurrency. Herein,
we aimed to enlarge the current literature by proposing a model of cryptocur-
rency market and value using the system dynamics approach.
To encourage research on modelling cryptocurrency market, this paper sum-
marised system dynamics’ basic tool – causal loop diagram. Afterwards, the
model was built using the mentioned methodology. Finally, the created causal
loop diagram was discussed in terms of feedback loops existing in cryptocur-
rency market. Chosen negative and positive feedback loops were presented.
Positive feedback loops are accountable for growth on the market (number of
miners, trading volume, coin price, etc), while negative feedback loops are ac-
countable for stabilizing behaviour (limiting growth of number of miners, trading
price, trading volume, etc).
During research we could identify several future directions of the study. The
first direction would be towards inclusion of more variables in the model. The
second future direction could be gathering data, creating stocks and flows di-
agram and running simulation experiments. The third future direction could be
the to conduct an agent-based simulation of the cryptocurrency market such
as been done by (Cocco, Concas and Marchesi, 2017). We believe our paper
might act as an incentive for further academic research on the application of
system dynamics for better understanding of the bitcoin and cryptocurrencies
value creation.

283
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286
 CHAPTER 17

Public R&D Expenditure Efficiency

and Knowledge Creation in CEE Region

Dalibor Greganić1, Milan Deskar-Škrbić2

ABSTRACT

In this paper we use Data Envelopment Analysis (DEA) to analyze the efficiency of
public expenditures on R&D in Central and Eastern European countries (CEE), using
knowledge creation and knowledge diffusion as key output indicators. Our results show
that most of CEE countries do not use public R&D resources efficiently and that current
level of expenditures should generate much higher results on Global Innovation Index
scale. So instead of increasing the level of public expenditures on R&D in our view
CEE countries need to increase efficiency first. In order to do so those countries should
continue to improve its institutional framework in terms of government effectiveness,
business climate and suppression of corruption. Increase of R&D efficiency is of great
importance for CEE countries as they seek for a new knowledge-based growth models,
which are more challenging for policy makers than pre-crisis models, based on physical
capital accumulation and adoption of technologies from abroad.

Key words: R&D, public sector, knowledge creation, DEA, CEE

JEL classification: O43, O34, O38

1. Introduction
According to Todaro and Smith (2014) there are three fundamental sources
of economic growth: (i) capital accumulation, including all new investments
in land, physical equipment, and human resources through improvements in
health, education, and job skills; (ii) growth in population and hence eventual
growth in the labor force and (iii) technological progress —new ways of accom-
plishing tasks. In this paper we will focus on the last growth factor as the con-
tribution of technological progress to economic growth is becoming even more
pronounced in new, digital era.

1 PhD Candidate; University of Zagreb; Director; Profil Klett; Petra Hektrorovića 2; 10000, Zagreb;
Croatia; Scientific affiliation: education, public sector economics; socio-economic development;
dalibor.greganic@profil-klett.hr
2 PhD Candidate; University of Rijeka; Senior Economic Analyst; Erste&Steiermarkische bank;
Ivana Lučića 2, 10000, Zagreb; Croatia; Scientific affiliation; public finance; fiscal policy; economic
growth; mdskrbic@erstebank.com

287
The importance of technological progress was already recognized in a pioneer
work by Solow (1956) in a neoclassical analytical framework. In these models
technological change is exogenous, it comes as a manna from heaven, and it
determines the long run growth rate of countries through the effects on long
run productivity. Although these models were a breakthrough in the economic
development and growth theory they missed to “internalize” the technological
progress into the models.
The situation has changed in 1990 after Paul Romer published its seminal paper
on endogenous technological change (Romer, 1990). In this paper Romer did
not challenge Solow’s main conclusions. Nay, in his view technological change
provides the incentive for continued capital accumulation, and together, capital
accumulation and technological change account for much of the increase in
output per hour worked. However, Romer went a step further and explained
that technological change arises in large part because of intentional actions
taken by people who respond to market incentives and invest in research and
development (R&D). In that sense technological progress in his model is en-
dogenous and not exogenous.
However, level of R&D expenditures per se cannot ensure adequate private or
social returns to investments in the economy. More precisely, if R&D resources
are not used efficiently (we use term efficient in terms of technical efficiently)
they can’t generate adequate outputs needed for sustainable technological pro-
gress. Thus in this paper we will analyze not only levels of R&D expenditures
but also the efficiency of these expenditures in CEE region. Our focus is on
public expenditures on R&D as we are interested in the public policy perspec-
tive of this topic.
In order to determine the efficiency of public expenditures on R&D we use
data envelopment analysis (DEA) approach. The key input in our analysis is
the total size of government budget appropriations or outlays on R&D. The
novelty in this paper is in chosen outputs as we don’t use usual outputs such
as number of patents or number of published scientific papers but the results
of Global Innovation Report, which in our view contain more info on knowl-
edge-creation, the key prerequisite for technological progress in some country.
Our main hypothesis is that most of CEE countries do not use public R&D
resources efficiently.
The paper is structured as follows. After the Introduction in the first part of the
paper, in the second part we present a brief overview of existing literature, with
the focus on papers using DEA approach. In the third part of the paper we brief-
ly explain the methodology, i.e. data envelopment analysis, while in the fourth
part we describe and analyze data used in the model. In the fifth part of the pa-
per we discuss the results while the last part of the paper contains conclusions
and policy recommendations.

288
2. Literature review

Werner and Souder (1997) divided research on R&D effectiveness and effi-
ciency into two categories: macro and micro. Macro-level techniques focus on
the impact of R&D on society as a whole. Micro-level techniques focus on the
impact of a firm’s R&D on its own effectiveness. In this paper we focus on
macro-level approach, cross-country comparisons and papers based on DEA
analysis. This literature is relatively scarce.
Although Teitel (1994) did not use DEA this paper is worth of mentioning as it
represents one of the benchmark papers in this field. The author showed that
investments to R&D can result in an increase of patents and improve scientific
results in various countries. This result motivated future research on R&D ex-
penditure efficiency.
Rousseau and Rousseau (1997) and Rousseau and Rousseau (1998) used
DEA in the analysis of R&D expenditure efficiency in developed countries. They
showed that there is a huge difference in efficiency across countries, meaning
that even highly developed countries can position below the technological fron-
tier. Based on DEA approach,
Lee and Park (2005) analyzed R&D efficiency in twenty-seven, mostly devel-
oped countries, and based on the results divided countries into four categories:
inventors (Finland, France, Germany, Japan, and United States), merchandis-
ers (Austria, Ireland, Norway, and Singapore), academics (Australia, Canada,
Hungary, Italy, New Zealand, Spain, and United Kingdom) and duds (China,
Czech Republic, Korea, Mexico, Poland, Portugal, Romania, Russian Federa-
tion, Slovak Republic, Slovenia, and Taiwan).
Wang and Huang (2007) analyzed R&D efficiency in thirty OECD and non-
OECD countries also taking into account environmental factors such as knowl-
edge of English language. They find that a large portion of the inefficiency can
be explained by a countryjs English proficiency indicator.
Sharma and Thomas (2008) used DEA to examine the relative efficiency of the
R&D process across a group of twenty-two developed and developing coun-
tries and documented a relatively high level of inefficiency in the R&D resource
usage in both group of countries. Thomas, Jain and Sharma (2009) analyze
R&D expenditure efficiency in twenty OECD countries, China and Russian Fed-
erations. The authors concluded that Asian countries have shown remarkable
progress in R&D efficiency which seems to be at the cost of the leading nations
like USA and the UK. As for the Asian countries, authors show that China ex-
hibits a rapid increase in number of scientific publications while the Republic of
Korea shows exemplary performance in patenting among residents

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Cincera, Czarnitzki and Thorwarth (2011) analyze the efficiency of R&D in
OECD and EU countries. The results show that to the most efficient countries in
terms of R&D public support are Australia, Canada, Finland, Germany, Japan,
Netherlands, New Zealand, Singapore, Switzerland, and the USA. 
Most comparable research to ours is Aristovnik (2012). Based on DEA method-
ology, author measured relative efficiency in utilizing public education and R&D
expenditures in the new EU member states in comparison to the selected EU
and OECD countries. Results showed that Cyprus and Hungary dominated in
the field of R&D sector. The empirical results also showed that, in general, new
EU member states show relatively high efficiency in tertiary education, while lag
well behind in the R&D efficiency measures.

3. Methodology
As we mentioned in the Introduction, in this paper we will use Data Envelop-
ment Analysis to determine the technical efficiency of public R&D expenditures.
In order to better explain why we use this type of efficiency measures we have
to remind that there are two main measures of efficiency in economics - alloc-
ative and technical efficiency. Allocative efficiency refers to how different re-
source inputs are combined to produce a mix of different outputs. Technical
efficiency on the other hand is concerned with achieving maximum outputs with
the least cost. The focus of this paper is on this type as we are interested in
rational use of public resources.
Data Envelopment Analysis (DEA) is a a deterministic, non-parametric, linear
programming technique for determination of so-called efficiency scores. DEA
scores reflect the distance between the respective data point, in this paper a
country, and the best practice point which lies at the frontier. The countries
(data points) on the frontier are given score of 1 while those inside the frontier
are given a score between 0 and 1. DEA provides a measure of relative effi-
ciency, meaning that it indicates that a country is the more efficient relative to
the other countries in the sample.
DEA can be input-oriented or output-oriented. Input-oriented method shows by
how much input quantities can be proportionally reduced without changing the
output quantities produced. On the other hand, output-oriented methods are
focused on the question by how much output quantities can be proportionally
expanded without altering the quantities of inputs used (for details see Coelli,
1996). Also, DEA can be based on the assumption of constant returns to scale
(CRS) or variable returns to scale (VRS). In this paper we use output-oriented
VRS approach as objective of R&D policies lies in increasing outputs rather
than decreasing inputs (Lee and Park, 2005).

290
DEA linear program is defined as:

(1)

(2)

(3)

xij is the amount of the i-th input, yrj is the amount of the r-th output, vi is the
weight given to the i-th input, ur is the weight given to the r-th output, and k
is the decision-making unit, in our case country, being measured. The 𝞮 con-
straints avoid any inputs or outputs being weighted at 0.

4. Data
As noted above, we are interested in the efficiency of public expenditures on
R&D, which represent input in our DEA analysis. Although many researches
use data on the share of public sector R&D expenditures in GDP we see this
indicator as deficient as it strongly depends on the level of development of
each country. Thus in this paper we use an alternative indicator, namely total
size of government budget appropriations or outlays on R&D as a share of total
government expenditures, obtained from Eurostat database. Indicator defined
in this way partially annuls the effects of differences in the level of development
among countries.
As for the outputs, in this paper we use data from Global Innovation Index
(GII) report as in our view complex indicators from this report provide a bet-
ter insight into the quality of knowledge and technology outputs than usually
used indicators such as solely number of patents or published scientific papers
across countries. Also, most of the indicators in this report are PPP-adjusted
which makes cross-country analysis more robust. As main outputs we use two
sub-categories of GII pillar VI “Knowledge and Technology Outputs” - Knowl-
edge Creation and Knowledge Diffusion” (for details see Dutta et al., 2017).
Knowledge Creation indicator combines data on number of resident patent ap-
plications filed at a given national or regional patent office (per billion PPP$
GDP); number of international patent applications filed by residents at the Pat-
ent Cooperation Treaty (per billion PPP$ GDP); number of utility model appli-
cations filed by residents at the national patent office (per billion PPP$ GDP);
number of scientific and technical journal articles (per billion PPP$ GDP).

291
Knowledge Diffusion indicator includes data on Charges for use of intellec-
tual property n.i.e., receipts (%, total trade); high-tech net exports (% of total
trade); telecommunications, computers, and information services exports (% of
total trade); foreign direct investment (FDI), net outflows (% of GDP, three-year
average)
Our sample includes eleven EU countries from Central and Eastern Europe
(CEE) region: Bulgaria, Croatia, Czech Republic, Estonia, Hungary, Latvia, Lith-
uania, Poland, Romania, Slovakia and Slovenia. Input is defined as 2011-2016
average, while outputs represent GII scores in 2017. Use of “lagged” values of
inputs is a standard approach in DEA analysis as it takes time for inputs, in our
case public expenditures for R&D, to give results in terms of outputs. For de-
tailed discussion on the use of average data see Graves and Langowitz (1996).

Definition Source
Government budget appropriations
Input or outlays on R&D as % of total government Eurostat
expenditures

Knowledge Creation score

Global Innovation
Outputs
Index
Knowledge Diffusion score

Table 1. Inputs and outputs in DEA model

Source: Authors

Scatter diagrams in Figure 1 and Figure 2 present data in a way useful for un-
derstanding DEA analysis background. X-axis contains data on input and y-axis
on output. Solid line “envelops” the sample by connection countries which pro-
duce maximum output at the given level of input.

Figure 1. Government expenditure on R&D and Knowledge Creation score

292
Source: Authors

Figure 2. Government expenditure on R&D and Knowledge Diffusion score

Source: Authors

These figures indicate that there is a high level of dispersion among CEE coun-
tries in terms of R&D expenditure efficiency. In addition, these figures suggest
that Czech Republic and Latvia could be regional leaders in that sense. It is
also interesting to notice that positions of countries are relatively stable regard-
less which indicator we observe. In the next section we will give more analytical
rigor to this discussion by employing DEA model on presented data.

5. Results and discussion

Tables presented below contain data on DEA efficiency scores and so-called
“target” outputs which show by how much should output increase to obtain
efficiency if the input stays unaltered. Score for efficient countries takes value
1 and those countries which are below “efficiency frontier” record scores in the
interval 0 < < 1.
Required increase
Country Efficiency score Target output
of output
Bulgaria 1 23.1 0
Croatia 0.41 46.8 27.5
Czech Republic 1 46.8 0
Estonia 0.66 46.8 15.5
Hungary 0.72 28.3 8.0
Latvia 1 13.0 0
Lithuania 0.43 33.6 19.0
Poland 0.78 31.0 6.8
Romania 0.37 25.7 16.2
Slovenia 0.79 33.6 7.1
Slovakia 0.62 33.6 12.9
Table 2. DEA results for knowledge creation
Source: Authors

293
Results presented in Table 2 show that three countries determine the “effi-
ciency frontier” for that sample - Bulgaria, Czech Republic and Latvia. Effi-
ciency scores for these countries equal 1. As these countries operate on the
efficiency frontier the size of their target output corresponds the size of their
real output, i.e. required increase of output is 0. Least efficient countries are
Romania, Croatia and Lithuania. Target outputs for these countries suggest
that, given the level of expenditures on R&D, Romania should increase its GII
score by 16.2 points, Croatia by 27.5 points and Lithuania by 19 points. Notice
that Croatia has higher efficiency score than Romania but requires stronger in-
crease in output to become efficient. This is because those countries don’t have
same peers. Peers for Romania are Latvia and Bulgaria and for Croatia it is
Czech Republic.

Efficiency Required increase

Country Target output
score of output
Bulgaria 0.94 45.72 2.92
Croatia 0.78 51.00 11.20
Czech Republic 1.00 51.00 0
Estonia 1.00 51.00 0.10
Hungary 0.90 46.53 4.83
Latvia 1.00 44.60 0
Lithuania 0.86 47.76 6.56
Poland 0.89 47.12 5.12
Romania 0.85 45.92 6.72
Slovenia 0.91 47.68 4.28
Slovakia 0.96 47.69 1.89
Table 3. DEA results for knowledge creation
Source: Authors

As for the results on Knowledge Diffusion, our model also recognizes three
benchmarks, but in this case those are Czech Republic, Latvia and Estonia. So
Czech Republic and Latvia are benchmark countries again. The interpretation
follows the lines from Table 2, meaning that now Czech Republic, Latvia and
Estonia recorded efficiency scores of 1 and required increase of outputs of 0.
Least efficient countries are again Croatia, Romania and Lithuania, but in this
case Croatia is positioned last. Required output increase results show that Cro-
atia would have to increase its GII score by 11.2 points, Romania by 6.7 points
and Lithuania by 6.6 points. Peer for Croatia is now Estonia and for other two
weak performers those are Latvia and Czech Republic.

6. Conclusion
There is no doubt that public investments in R&D are important part of broad-
er economic policy, especially in modern economies where technological pro-
gress, often expressed through concept of total factor productivity (TFP), is
becoming more important in growth creation process. However, the size of

294
investments cannot ensure the adequate social returns by itself. It is important
that public R&D expenditures are used efficiently, meaning that for a given level
of inputs they give maximum outputs. Efficiency of public expenditure is of great
importance in CEE region as lot of countries have a history of fiscal unsustain-
ability and were compelled to cut its budget spending during the period after
2008 financial crisis.
Results presented in this paper confirm our working hypothesis that most of CEE
countries do not use public R&D resources efficiently, especially in knowledge
creation process. Such inefficiency can partially explain relatively low ranks of
CEE countries on Global Innovation Index scale, where those countries are
among the weakest performers in European union. This is alarming as litera-
ture on economic growth shows that as economies’ incomes rises, productivity
growth fails to keep up, with countries finding it difficult to switch from a growth
model based on investment and the adoption of technology to one involving in-
novation and the development of new technology. Most of CEE countries are in
a category of high income countries (based on World Bank definition) and thus
require new knowledge-based growth model. So instead of increasing the level
of public expenditures on R&D in our view those countries need to increase the
efficiency first. In order to do so CEE countries should continue to improve its
institutional framework in terms of government effectiveness, business climate
and suppression of corruption (it is interesting to point out that CEE countries
are still ranked relatively low on Corruption Perception Index scale and that
Romania and Croatia, which were marked as lest efficient in this paper, have
among lowest scores in CEE).
The main contribution of this paper is the use of inputs and outputs which were
not used in existing literature so far. As explained in the main text, in our view
these variables are more adequate for the analysis than ones which are most
commonly used. In addition, this is the first paper that investigates efficiency
of R&D in terms of knowledge-creation and knowledge-diffusion in Central and
Eastern Europe region. In the future research efficiency scores obtained from
DEA analysis in this paper can be used in broader econometric analysis in
which efficiency of public R&D expenditure could be regressed directly on GDP
growth rates in order to show that R&D efficiency is more important for long
term growth than levels of expenditures per se.

295
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Cincera, M., Czarnitzki, D., & Thorwarth, S. (2011) „Efficiency of public spending
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(computer) program.  Centre for Efficiency and Productivity Analysis”,
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pp.207-222.

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Economy, Vol.98, No. 5, pp.71-102.

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297
 CHAPTER 18

How does the digitalization impact society’s

sustainable development? Measures and implications

Milica Jovanović1, Jasmina Dlačić2, Milan Okanović3

ABSTRACT

This paper examines the relationship between digitalization and sustainable develop-
ment and presents the composite index used for measuring the digital competitiveness
of nations – the Digital Economy and Society Index (DESI). To be competitive on a glob-
al market, it is not enough just to have an efficient government and flourishing economy.
Today’s environment is highly dependent on the technological capabilities and keeping
track with contemporary technological development is becoming crucial at both micro
and macro level. One of the major revolutions in modern business is switching from
traditional to digital business models for achieving higher competitiveness level. Dig-
italization is one of the major impetus of today’s development. For accepting and im-
plementing those changes, it is important to highlight the macromarketing role in this
process. To identify the shortcomings, good practices, and track the development, it is
necessary to have concrete measures. European Commission developed a composite
index for measuring digital performance of European Union countries - DESI. This paper
examines the methodology of DESI and observes how the digital performance of EU af-
fects main sustainable development components: economic, social, and environmental.
Thus, paper explores the correlations of DESI and other composite indices that measure
sustainability components: competitiveness, innovation, gross domestic product, entre-
preneurship, “goodness” of a country, and contribution to the sustainable development
goals. In addition, paper examined the influence of Hofstede’s cultural dimensions on
digital performance. The highlight the importance of digitalization as another crucial
component of sustainable development and society.

Key words: Digitalization, Sustainable development, Performance indicators,

Society, Macromarketing

JEL classification: JEL_ Q01, JEL_E71, JEL_ M38

* This paper is published in Proceedings of Rijeka Faculty of Economics-Journal of Economics

and Business/Zbornik Ekonomskog fakulteta u Rijeci: časopis za ekonomsku teoriju i praksu, Vol.
36, No.2, pp. 905-928, DOI: https://doi.org/https://doi.org/10.18045/zbefri.2018.2.905
1 Teaching assistant, University of Belgrade, Faculty of organizational sciences, Jove Ilića 154,
11000 Belgrade, Serbia. Scientific affiliation: MSc, PhD student. Phone: +381113950879. E-mail:
milica.jovanovic@fon.bg.ac.rs
2 Assistant professor, University of Rijeka, Faculty of economics, Ivana Filipovica 4, 51000 Rijeka,
Croatia. Scientific affiliation: PhD. Phone: +38551355169. E-mail: jasmina.dlacic@efri.hr
3 Assistant professor, University of Belgrade, Faculty of organizational sciences, Jove Il-
ića 154, 11000 Belgrade, Serbia. Scientific affiliation: PhD. Phone: +381113950848. E-mail:
milan.okanovic@fon.bg.ac.rs

299
1. Introduction
Throughout history, main radical changes that shaped today’s society are in-
dustrial revolutions. Four eras of technology deeply changed everything that
surrounds us, and affects everyday life (Schwab, 2016). Medicine, educa-
tion, transport, manufacturing, banking, business, sports, food industry, etc.:
everything changed under the influence of these major changes. In this world
of fast changes, man forgot about his natural habitat, his environment. We are
constantly developing technologically, but sometimes the costs are great. Thus,
it is important to measure the impact that technological changes have on sus-
tainable development, the synergistic development of economy, society, and
environment.
Recently, there is an emergence of various measures of national performance.
Numerous indices are used with aim to measure different aspects of a nation’s
economic development: competitiveness, innovativeness, entrepreneurial ac-
tivity, etc. (Jovanović et al., 2017). However, there are indices oriented towards
measuring different national phenomena, such as goodness of a country, which
inspects contribution of a nation to the humanity; or overall sustainability, meas-
uring contribution to sustainable development goals. In these recent trends,
another index emerged because of the rapid digital development: The Digital
Economy and Society Index (DESI). In this paper, we examined the digitaliza-
tion impact on the main sustainability components: economy, society, and en-
vironment. We inspected the correlation of DESI with selected methodologies
that measure different aspects of sustainability dimensions. We also examined
the relationship between cultural characteristics and digitalization level of a
country by exploring correlations of Hofstede’s cultural dimensions and DESI.
Next section explains main concepts examined in this paper: digitalization, sus-
tainable development, macromarketing, relationship between sustainable de-
velopment and digitalization, with special emphasize on DESI. This section is
followed with the section that presents the methods used for the research, and
with section where results of the research are presented as well as discussion
and implications are provided. Finally, we complete the paper with the conclu-
sions of the research.

2. Literature review
Today’s environment is highly dependent on technological capabilities and
keeping track with contemporary development is becoming crucial at both mi-
cro and macro level. Today’s societal characteristics are highly influenced by
the industrial revolutions occurred in the last three centuries. Revolutions have
occurred throughout history when new technologies and novel ways of per-
ceiving the world trigger a profound change in economic systems and social
structures (Schwab, 2016). From the steam machine in 1760’s technology has
developed exponentially, by constantly developing itself and behaving as a sort

300
of recursion where new technologies were created on a basis of the old ones.
Schumpeter explained this phenomenon through his waves of innovation (Fig-
ure 1), explaining that each wave of innovation does not lasts equally, and that
their length is shortened due to the rapid development of new technologies
(The Economist, 1999; Levi Jakšić et al., 2018). Currently, we are living in the
5th wave of innovation, where digital solutions are becoming the leading impe-
tus of change.
One of the major revolutions in modern business is switching from traditional
to digital business models for achieving higher competitiveness level. In this,
fifth wave of innovation, we can distinguish three eras of digital transformation
(I-scoop, 2016):
1. Digitization: where the analog items are converted into digital versions
(i.e. electronic version of paper documents);
2. Digitalization: where digital technologies are used to change business
models, create revenue, improve business and value-producing oppor-
tunities; and
3. Digital transformation: where digital technologies are used to change all
business aspects.

Figure 1. Schumpeter’s long waves of innovation

Source: Levi Jakšić et al. (2018)

Chronologically speaking, we live in the third era of digital transformation, and

new challenges are put in front of governments, companies, entrepreneurs,
and customers/consumers (Schwab, 2016). Schmarzo (2017) stresses that
this era of digital transformation represents “application of digital capabilities to
processes, products, and assets” all with aim to “improve efficiency, enhance

301
customer value, manage risk, and uncover new monetization opportunities.”
Similarly, others (Bertini, 2016) points out that digital transformation is influenc-
ing not just lives but also individual’s experiences.
Dang & Pheng (2015) explored new theories of economic development, and
well noted, “on the way to achieve rapid economic growth, countries around the
world have been exploiting their natural resource reserves at alarming rates”.
Both science and society have noticed this occurrence, and consequently sus-
tainable development has been increasingly highlighted as a priority for nations
and enterprises. Brundland Commission (1987, p. 41) states that: “Sustainable
development (SD) is development that meets the needs of the present with-
out compromising the ability of future generations to meet their own needs.”.
This concept suggests that the well-being of humanity can be achieved only
by the synergistic of three basic pillars: economic growth, social equity, and
environmental protection. Additionally, due to the complexity of today’s socie-
ty, culture has been identified as the fourth dimension of sustainable develop-
ment (Commonwealth Secretariat, 2007; Hawkes, 2001). Organization Culture
21 states that “culture ultimately shapes what we mean by development and
determines how people act in the word“ (Culture 21, 2014). This component
of SD is important because it determines how the changes will be accepted
in the society. Thus, it could be a crucial factor for adoption of digital trans-
formation process. Some authors in criticizing the SD definition given by the
Brundland Commission even consider 5 determinants of sustainable develop-
ment (Seghezzo, 2009): Place: with three dimensions of space; Permanence:
dimension of time; and Persons: human dimension. However, this concept is
too abstract to be applied, and not sufficiently explored and scientifically con-
firmed. Recent researches also examine the influence of culture on accepting
digitalization. Benner (2017) analysed the impact of the cultural acceptance
of digitalization on the GDP in East and West Germany. The research based
on measuring the data form Google Trend, where the term “Facebook” oc-
curred as a search term. The results showed that positive cultural acceptance
of digitalization increases GDP. However, this research did not include the re-
maining SD dimensions. On the other hand, Hegyes, Csapó, & Farkas (2017)
examined the problem of digitalization and sustainable development by com-
paring Hungary with other EU countries. The research based on the European
Comission reports and empirical research in secondary education. Again, the
results did not give the whole picture of the digitalization impact on sustainable
development components, but they put the focus on Hungarian performance
in comparison to EU.
In these kinds of societal changes, macromarketing is also getting the attention.
In this paper, we want to highlight the importance of this concept, which has
been unfairly neglected and in the shadow of micromarketing. In every indus-
try, managers are paying special attention to the marketing activities. Often,
marketing determines the success of the companies, distinguish them from the
competition, and not so rarely brings the competitive advantage on the market.

302
When it comes to macromarketing, the concept itself is not so familiar.
Unlike micromarketing, macromarketing is more oriented toward social aspects
of marketing and institutions (Bartels & Jenkins, 1977). This concept tries to
explain the functioning of complex marketing mechanisms of economic and
social environments. As such, it is identified as an important determinant of
sustainable development. Kilbourne, McDonagh, & Prothero (1997) claim that
only macromarketing can effectively examine the relationship between sustain-
able consumption and quality of life. They recognize four dimensions: tech-
nology, economics, ethics and politics as crucial for determining sustainable
consumption. By fostering macromarketing activities and mechanisms for ac-
tion (information, individual actions, participation of business, mesuring indi-
cators, political support of government) it is possible to transform society from
the state of hyperconsumption to the desired state of sustainable consumption
(Kilbourne, McDonagh, & Prothero, 1997). Macromarketing activities are the
ones that encourage behavioral change of society by rising awareness, and
are also responsible for accepting the radical technological changes (i.e. digital
transformation) (Shultz, 2007). Shultz & Peterson (2017) noticed socioeco-
nomic transition in Vietnam to a market-oriented economy, and thus examined
the macromarketing aspect of their performance. They examined the Sustain-
able Society Index values with macromarketing activities and concluded that
it is crucial to foster macromarketing activities in order to achieve sustainable
society. In the process of adopting changes macromarketing can be used as a
tool that takes into consideration different cultural aspects of the society where
the change is being implemented. Consequently, in the process of digital trans-
formation of the society it is important to consider different cultural dimensions.
Having in mind the emergence of digital transformation process, importance of
sustainable development issue, and the intermediary role of macromarekting,
we proposed two research questions:
Whether and to what extent digital transformation affects the sustainable devel-
opment and its components?
Whether digital transformation level is affected by the cultural characteristics
of a society?
Thus, in this paper, we compare the measures of digitalization performance
with measures of sustainable development (as a whole concept, as well as
the components). For the purpose of the research, we observed the cultural
dimensions as an important component of both sustainable development and
macromarketing. We based our conclusions on a set of 28 EU countries. For a
measure of digitalization, we observed The Digital Economy and Society Index
and compared the results with the rest of the indicators related to the sustaina-
ble development components.

303
2.1. The Digital Economy and Society Index
To measure the level of achieved digitalization in a country, European Com-
mission developed The Digital Economy and Society Index (DESI), a compos-
ite measure that summarises indicators related to the digital performance and
digital competitiveness of the EU member states. It is compounded of a set
of indicators related to the digital policy mix, and has a three-layer structure
(European Commission, 2017). At first level, there are five principal dimen-
sions: Connectivity, Digital skills, Use of Internet, Integration of Digital Tech-
nology, and Digital Public Services. Second level has 12 sub-dimensions, and
the third level has 31 individual indicators. Complete structure of DESI with the
weighting system is presented in Figure 2. The five principal dimensions are
defined by the five principal policies for digital economy and society. European
Commission (2017) claims that the digital development of the economy and
society can only be achieved by interconnected development of these areas
(European Commission, 2017). As technological changes occur, this index is
also changing the methodology, so in 2016, they included some new indicators
in calculation (i.e. 4G coverage).
Considering weighting system used for the computation of the final DESI score
not all the dimensions have the same share: Connectivity and Human Capital
are having the largest impact with 25% each, then Integration of Digital Tech-
nology with 20%, while Use of Internet and Digital Public Services have the low-
est impact of 15%. Within dimensions, the sub-dimensions also have different
weighting system shown in Figure 2 (European Commission, 2017).

Figure 2. Digital Economy and Society Index structure

Source: Authors, based on European Commission (2017)

304
Analysing the structure and methodology used for computation of the DESI,
we can conclude that the indicators are carefully examined, selected and in
accordance with the problem they should measure. Also, since one of the big-
gest shortcomings of numerous global index methodologies is equal weighting
system (Jovanović et al., 2017), we can say that this is not the case with DESI,
and that different significance of certain digitalization aspects has been taken
into account. Finally, all indicators at the lowest level of hierarchy are quantita-
tive, so they provide objective measures of performance in terms of achieved
level of digitalization.
To objectively examine the relationship between the digitalization process and
sustainable development, we measured the correlation between the DESI
and selected set of indicators that measure certain (or all) aspects of sustain-
able development. We compared the DESI results with the following global
methodologies:
• Global Competitiveness Index
• Global Innovation Index
• Gross Domestic Products
• Global Entrepreneurship Index
• The Good Country Index
• Sustainable Development Goal Index
• Sustainable Society Index
There are still not methodologies widely accepted for measuring overall concept
of sustainability, but still including one or more SD dimensions. In this research
we use indices explicitly defined for this purpose, but since these are young
methodologies (Sustainable Development Goal Index started being measured
in 2015), or not measured each year (as Sustainable Society Index), we used
measures that relate to some SD dimensions and are widely accepted.
We wanted to examine macromarketing role in the process of digitalization, so
we included measures of Hofstede’s cultural dimensions in the research. Also,
culture is identified as a fourth dimension of SD, but not included in any official
methodology for measuring sustainability level. Thus, this was another reason
to include cultural aspect in the research.
Since not all the indices are related to measuring all SD components, we clas-
sified them based on set of indicators they are compounded of (Table 1). After
the explanation of each methodology, we noted the dimension they relate to.

305
3. Methodologies used in the research
Further, we will briefly explain the subject matter of each index. Global Compet-
itiveness Index (GCI) is index measured by the World Economic Forum, and
assesses the global competitiveness of 137 countries. It also gives an insight
into the catalysts of the economy that are crucial for the further development
and prosperity (WEF, 2017). The indicators of this methodology are oriented
on economy (i.e. quality of roads, pay and productivity, company spending on
R&D, etc.) and society development (i.e. Secondary education enrolment rate,
Internet users, quality of education, etc). Global Innovation Index (GII) meas-
ures innovation performance of 127 world economies. Cornell University, IN-
SEAD Business School, and World Intellectual Property Office annually publish
The Global Innovation Report and provide data related to the innovative activity
of countries through the set of 81 indictors (Cornell University et al., 2017).
As with GCI, the components this index relates to are economy and society.
As only single indicator used for the comparison with the digitalization level
we included Gross Domestic Product (GDP), as one of the main indicators
of a country’s economic performance (Syrquin, 2011). We also examined the
scores of the Global Entrepreneurship Index (GEI) published by the Global
Entrepreneurship and Development Institute. This index measures the health
of 137 entrepreneurial ecosystems by measuring entrepreneurial attitudes,
abilities and aspirations (GEDI, 2017). Although, entrepreneurial activities are
not an explicit part of the sustainable development, they relates to the social
activities within the economic system, so it is also connected to the economy
and society dimensions of SD. Another global index examined in the research
offers a slightly different perspective – the Good Country Index (GoCI). Un-
like other indices that are oriented mostly towards economic and social perfor-
mance, this index measures the contribution of a country to “the common good
of humanity” (Good Country, 2016). The Good Country organization collects
the data from the official institutions and evaluates the “goodness” of a country
through its contribution to seven dimensions: Science and Technology, Culture,
International Peace and Security, World Order, Planet and Climate, Prosperity
and Equality, and Health and Wellbeing. Unlike previous indices, we compared
this index with all the dimensions, since it relates to all three sustainability as-
pects: economy, environment and society. The listed indicators are not primar-
ily oriented towards measuring sustainability, but are focused on one or more
dimensions. Thus, we included methodologies developed solely to measure
the sustainable development: Sustainable Development Goals Index and Sus-
tainable Society Index.
Sustainable Development Goals Index (SDGI) is the result of a worldwide study
that evaluates how much each country contributes achieving the Sustainable
Development Goals. The Sustainable Development Solutions Network and the
Bertelsmann Stiffung annually publish these reports with guidelines to leaders
how can identify priorities and track progress in achieving the goals. Sustainable
Society Index (SSI) is another measure of sustainability level that the Sustainable

306
Society Foundation publishes every two years. The SSI framework calculates
the performance at three levels: 21 indicators, 7 categories, and 3 basic SD
dimensions (Economic, Environmental, and Human Wellbeing) (SSF, 2016a).
However, specifics of this index are that it does not provide aggregate measure
of sustainability, but three different scores for each dimension. Thus, we com-
pared the DESI result with each of three SSI components.
Since none of the listed indices does not include cultural perspective of a na-
tion, although it is identified as an important component of adopting technologi-
cal changes, we included Hofstede’s cultural dimension results for the selected
set of countries, as Hofstede’s cultural dimensions approach to measuring cul-
ture is one of the most widely used values surveys (Masleand & Hoorn, 2009).
We explored correlations with each of six defined dimensions. Each country
achieves a certain score on a scale from 0 to 100. Power Distance dimension
describes the level of orientation towards hierarchy. Those countries that have
high scores on this dimension accept unequal distribution of power, since low
scores mean that power is equally distributed among society. Individualism vs.
Collectivism describes the strength of the community in the society. High score
on this dimension means that people are not willing to take other people’s re-
sponsibility, unlike those with low scores that are loyal to the group they belong
to and stand for their interest. Masculinity vs. Femininity describes the roles of
men and women in society. Highly masculine societies defer the roles depend-
ing on the gender, and money and achievement are important determinants of
success, while the feminine societies more orients towards the quality of life,
and it is considered that men and women roles are overlapping. Uncertainty
Avoidance measures the level to which people are willing to deal with the anx-
iety and are capable to accept the risk. High scores on this dimension defines
that society prefers situation that they can control and situations that can pre-
dict, while the lower score signifies the relaxed and opened communities. Long-
term orientation describes the degree to which people are oriented on past
and tradition. Low score nations are more religious, nationalists, and are not
easy to accept societal changes and thus are marked as short-term oriented,
while high scores describes the nations which are more persistent, pragmatic,
thrifty, and respect education. Indulgence vs. Restraint measures the society’s
characteristics in terms of enjoying life. Nations with low scores are restraint,
pessimistic and are regulated by strict social norms, while high score describes
societies that are more optimistic and focused on personal happiness (Hofst-
ede G., 2011).

4. Research results and discussion

To compare the results and derive conclusions, we collected data from 2014
to 2017 (since the European Commission started measuring DESI in 2014) for
EU countries (the scope of DESI). SDGI values are available only for 2016 and
2017, while SSI is measured every two years and thus the results are provided
only for 2014 and 2016.

307
Measure SD component Data source
WEF (2014) WEF (2015)
GCI Economy, Society
WEF (2016) WEF (2017)
Cornell University,
INSEAD, & WIPO (2014)
Cornell University,
INSEAD, & WIPO (2015)
GII Economy, Society
Cornell University,
INSEAD, & WIPO (2016)
Cornell University,
INSEAD, & WIPO (2017)
GDP Economy Eurostat (2018)
GEDI (2014) GEDI (2015)
GEI Economy, Society
GEDI (2016) GEDI (2017)
GoCI Economy, Society, Environment Good Country (2017)
SciTech Economy
Culture Society
Intern.Peace & Security Society
World Order Society
Planet & Climate Environment
Prosperity and Equality Economy, Society
Health and Wellbeing Economy, Society
Kroll (2015) Sachs et al. (2016)
SDGI Economy, Society, Environment
Sachs et al. (2017)
SSI Economy, Society, Environment SSF (2016b)
HCD Culture Hofstede Insights (n.d.)
Table 1. SD dimensions and data source for the selected indices
Source: Authors

All data was collected from the official reports, websites, and databases, and
the sources are given in Table 1. Also, in the table are listed the dimensions
of sustainable development which performance is measured by the selected
indices, since not all of them are focused on all SD dimensions. For the cal-
culation of correlation, we used StatSoft’s software Statistica (StatSoft, 2018).
We measured the Spearman’s correlation coefficient for comparing the Good
Country Index and DESI since the data from the GoCI methodology is ordinal
(ranks). For the rest of the data, we calculated Pearson’s correlation coefficient.
The results are presented in Table 2.
The results sow that the most of the measures significantly correlate with the
DESI values (numbers flagged). GCI, GII, and GEI have strong positive corre-
lation with DESI for each year (from 0.7667 to 0.8856) which means that the

308
highly digitalized countries are more likely to be more competitive, innovative,
and entrepreneurially oriented on the global market. The similar situation is
with the GDP level, which show high positive correlation from 0.6125 to 0.6623
with DESI index, which is expected, because higher digitalization level can be
related to the higher standard level of the countries. However, it is not as high
as the previous measures, which proves that the economic standard is not the
only aspect that is related to the more digitalized societies.

DESI
Measure SD component
2014 2015 2016 2017
GCI Economy, Society 0.8047* 0.8655* 0.8546* 0.7667*
GII Economy, Society 0.8071* 0.8745* 0.8682* 0.8564*
GDP Economy 0.6687* 0.6827* 0.6614* 0.6883*
GEI Economy, Society 0.8797* 0.8712* 0.8856* 0.8521*
Economy, Society,
The GoCI 0.6125* 0.6623* 0.6519* 0.6377*
Environment
SciTech Economy 0.3175 0.3290 0.3372 0.2874
Culture Society 0.7767* 0.8095* 0.8161* 0.8084*
Intern. Peace & Security Society 0.2759 0.3131 0.3098 0.2868
World Order Society 0.5249* 0.5397* 0.5008* 0.5101*
Planet & Climate Environment 0.1527 0.1587 0.1637 0.1544
Prosperity and Equality Economy, Society 0.5435* 0.5955* 0.6015* 0.5709*
Health and Wellbeing Economy, Society 0.7225* 0.7564* 0.7493* 0.7504*
Economy, Society,
SDGI 0.8302* 0.6771*
Environment N/A N/A
Economy, Society, N/A N/A
SSI N/A N/A
Environment
Human Wellbeing Society 0.5488* N/A 0.6132* N/A
Environmental Wellbeing Environment -0.5642* N/A -0.5890* N/A
Economic Wellbeing Economy 0.3156 N/A 0.3199 N/A
Power distance Culture -0.7201* -0.7079* -0.6992* -0.5613*
Individualism Culture 0.5593* 0.5607* 0.5528* 0.5980*
dimensions

Masculinity Culture
Hofstede’s

-0.3814 -0.3610 -0.3870 -0.3465

Uncertainty Culture
-0.6427* -0.6598* -0.6470* -0.5791*
Avoidance
Long term Culture
-0.0681 -0.0772 -0.0920 0.0295
orientation
Indulgence Culture 0.6932* 0.7092 *
0.7246 *
0.6844*
Table 2. The correlation results significant at p< 0.05; N/A – the data was not available
for the observed years
Source: Authors

The Good Country Index also has strong positive correlation with DESI (from
0.6125 to 0.6623). These results show that countries with higher level of dig-
italization also contribute more to humanity. This can be also viewed as a

309
certain aspect of sustainability, if we conclude that these kinds of contribution
and responsible behaviour are leading towards higher sustainability. If we ex-
amine the components of GoCI, Science and Technology development have
low positive relationship with DESI, which at first do not seem logic, but this
value in the GoCI methodology computes on a basis of number of international
students, journal exports, international publications, Nobel prizes, and patents,
and is not closely linked to ICT development. Cultural component, however,
has strong positive relationship with digitalization level, as well as Health and
Wellbeing. World order, and Prosperity and Equality have medium positive cor-
relation with the level of digitalization. These results again emphasize that so-
cial components of the countries are influenced positively with the process of
digitalization. On the other hand, for International Peace and Security it is not
identified statistically significant relationship, although it is positive. In addition,
for Planet & Climate component, the only component related to environmental
dimension, there is a weak positive correlation, which means that does not
have statistically significant relationship with digitalization level.
If we look into the sustainability indices, SDGI also strongly correlates with the
DESI with correlations of 0.8302 and 0.6771. This implicates that, according
to these methodologies, more digitalized societies tend to perform better in
achieving sustainability goals. Yet, to have another perspective, we can look
into the SSI correlation results, since this index diversifies three components
related to the sustainability dimensions and does not provide a single (com-
posite) measure of sustainability. Human Wellbeing component related to the
society dimension has positive relationship with the digitalization, meaning that
digitalized societies have more satisfied basic needs and better education.
Yet, in comparison to Environmental Wellbeing, DESI has negative relation-
ship. This is an important implication, since it signifies that societies with higher
digitalization level are scoring low in terms of climate, energy use, renewable
energy, consumption etc.
From a cultural perspective, the results show that Power Distance dimension
has high negative correlation with DESI. The result indicates that societies with
high hierarchical structures are less digitalized than the ones with the equal-
ly distributed power. Also, Individualism has medium positive correlation with
digitalization (0.5528 to 0.5980), which shows that collectivistic societies have
lower level of digitalization than the individualistic. Although the relationship
is not statistically significant, Masculinity has weak negative correlation with
DESI, which is very specific, since the masculine societies are driven by the
success, competition and achievement. The results also show that countries
that are more risk oriented (have lower Uncertainty Avoidance scores) tend
to be more digitalized according to the medium to strong negative correlation
scores (-0.5791 to -0.6470). Surprisingly, Long term orientation does not detect
any relationship with the digitalization level. That signifies that there are no dif-
ferences found in accepting the digitalization between the traditional societies
and those that are future oriented. In the end, Indulgence has strong positive
correlation with the level of digitalization. This result indicated that the level of

310
digitalization is higher in the societies, which are freer to enjoy life and have fun
in comparison to the restraint countries that resist the fulfilment of their desires.

4.1. Limitations and future research directions

Although we have derived important implications, this research has certain lim-
itations. Firstly, the set of countries is narrowed to 28 EU countries because of
the scope of DESI. This is important because cultural differences may be even
stronger, and conclusions may significantly differ when the rest of the world
countries are included (especially Asian and African). However, this is not pos-
sible to change if some new official measure occurs or the European Commis-
sion methodology changes the scope for DESI. Regarding methodologies for
measuring sustainable development, SDGI is still young methodology, and SSI
is not measured annually and does not provide unique score on sustainability.
In this research, we used Hofstede’s model of cultural dimensions exploring
values and relationship with society impact on DESI, but there are other meth-
odologies that can be examined for this purpose and to determine relation-
ship with macromarketing efforts. Fons Trompenaars and Shalom Schwartz
developed their own models of cultural dimensions (Fons Trompenaars &
Charles Hampden­Turner, 2000; Schwartz, 2006), so the examination of rela-
tionship between these two modes and digitalization and sustainability will be
the subject of further research. Also, in future, there is a possibility to structure
the model of implications for policy makers with specific macromarketing tools
that should be applied for easier implementation of technological changes into
society based on the cultural dimensions.

5. Conclusions
Technological changes are rapid. They are significantly shaping our society.
Since the length of the waves is shortening, it demands quick and agile reac-
tion on the market. Currently, we are living in the era of digital transformation.
Digital technologies are changing all business aspects and new challenges are
occurring. In adopting these changes, macromarketing has a special role with
its specific tools. Nonetheless, man must not forget his natural environment in
chasing the economic development. Thus, developing sustainably has been
set as a priority action. Two questions emerge: Whether and to what extent
digital transformation affects the sustainable development and its components?
and Whether digital transformation level is affected by the cultural characteris-
tics of a society?
For answering posted questions, we conducted a research where the digitali-
zation measure of EU countries is compared with other established methodol-
ogies that measure one or more sustainability components. The results show
that digitalization significantly relates with the sustainable development com-
ponents. The higher digitalization level is in a relationship with the economic

311
development through higher competitiveness, innovativeness, and entrepre-
neurial activities. Also, GDP is higher in more digitalized countries. Neverthe-
less, not just economic development, but the social aspect is also positively in-
fluenced by the digitalization. However, environment is neglected with medium
negative impact of the digitalization. Based on correlations results between dif-
ferent Hofstede’s cultural dimensions and digitalization it is noted that cultural
differences have large impact on the process of digitalization. More hierarchy,
individualism, risk orientation, and readiness to enjoy life are leading to higher
digitalization. On the other side, traditional societies has the similar digitaliza-
tion level as the future oriented ones. This also leads to the conclusion that
macromarketing has an important role in accepting digitalization, if the tools are
used and shaped in accordance with nation’s cultural characteristics.
It has been noted during the research that methodologies used for measuring
the sustainability level are not developed enough, and that more focus is put
on the economic and social development. Also, we based our conclusions on
DESI, measured only for the EU countries. We examined the methodology and
derived the conclusion that it has been carefully developed, with the appropri-
ate structure and weighting system. Since the digitalization is an important as-
pect of today’s development, DESI should have wider scope than 28 countries.
This would enable future research with a more representative set of countries
for deriving conclusions, especially in terms of cultural characteristics that are
important for shaping the implementation set of actions.

Acknowledgment
This paper has been financially supported by the University of Rijeka for project
ZP UNIRI 9/17.

312
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 PART 5

CONTEMPORARY ISSUES OF LOCAL ECONOMIC

DEVELOPMENT
 CHAPTER 19

Smart city concept and alternative procurement models

as instruments for reduction taxpayers and authority
agency costs in public investment projects

Damir Juričić1

ABSTRACT

Stakeholders in corporations like owners, managers, suppliers or lenders are well in-
formed about agency costs caused by informational asymmetry. This topic is, on a cor-
porate level, comprehensively researched and well known for a long time. However,
agency costs, caused by informational asymmetry on a public organisations level like
cities, counties or public corporations, caused informational asymmetry which have
stakeholders like taxpayers, public management (mayors, public managers), members
of the city councils, are insufficiently explored, specially instruments for reduction of
agency costs.
The new paradigm of collecting, managing and using information, as well as alternative
public investment procurement models within the concept of “smart cities”, could be a
significant factor in reducing information asymmetry among entities in public organiza-
tions, thus increasing the efficiency and effectiveness of public organizations and value
for taxpayers money.
In this paper the attention will be focused to defining of taxpayers agency costs caused
by informational asymmetry in relation taxpayers – authority as well as authority – cor-
porations in traditional and alternative procurement of public investment projects. Also,
there are a brief review of possible instruments for reducing principal’ cost in monitoring
the agent.

Key words: Agency costs, informational asymmetry, value for money,

taxpayers, project finance

JEL classification: G38, H80

1. Introduction
The whole process of contracting a specific business relationship can be divid-
ed into two sub-processes: a sub-process that determines relationships and
behaviors prior to the conclusion of the contract and the sub-process that re-
lates to the period after the contract is concluded (its execution). The basic
feature of both processes is that, in most cases, the contracting parties have

1 Damir Juričić, PhD. Center for Support to Smart and Sustainable Cities, University of Rijeka,
Deputy Managing Director, damir.juricic@uniri.hr

319
different information on the contracting subject (procurement, delivery, produc-
tion and the like) which is referred to as the asymmetric information relationship.
This informational asymmetry between the contracting parties, for the party
with less information on the subject of the contract, creates costs that are called
agency costs in economic theory. A contracting party with more information on
the contracting subject is called the agent while the contracting party with less
information is called the principal. In such an asymmetric relationship the agent
achieves a benefit in relation to the principal, e.g. in the position to appropriate
most of the total created value deriving from the contractual relationship.
Agency costs are manifested, at least it’s presented like so in theory (Sung,
2005), through two forms of behavior: adverse selection and moral hazard.
Adverse selection occurs usually in the period before the contract is conclud-
ed, while moral hazard occurs after the contract has been concluded. Adverse
selection represents the situation within which the principal selects the agent
in the circumstances when the principal does not have enough relevant and
available information about the agent and that information won’t have until the
agent is selected. Moral hazard represents the relationship in which the agent,
who is now engaged by a principal to perform a particular job, uses excess
information in relation to the principal for the purpose of engaging a minimum
effort to execute a contract, e.g. the agent acts as an opportunity.
Described universals and processes can be observed in the public sector
among different participants. Firstly, that is the relationship between voters and
candidates in the election process. In this process, voters have less information
about the final execution of the promises of the candidates when they come in
to the power. In this relation, voters are in the position of principal while candi-
dates are in a position of agents. Voters are exposed to adverse selection risk.
Secondly, when the candidates came to the power they become the authority
and are now in the position to deliver promises to voters (who now come in
the role of taxpayers and users of public services). Thirdly, the authority de-
livers public projects (public services, public infrastructure, in general, public
projects), especially infrastructural ones, higher capital value, in the way so
that they engage other people with whom they enter in contracting relationship.
However, in this relationship the authority is in the role of principal while the
third party (more frequently, construction companies) are in the role of agent,
Now the authority is exposed to adverse selection risk in the procurement pro-
cess (before concluding the contracts), while after the conclusion of the con-
tract the moral hazard risk is exposed.
In this paper, instruments that could be used by taxpayers and authorities for
the purpose of reducing agency costs and preserving value for money are be-
ing analysed. It is about the potential of applying alternative procurement mod-
els (concessions, PPP, EPC etc.) and ICT (smart city concept).

320
2. Literature review
Agency costs theory has been used in numerous fields as accounting, econom-
ics, finance, marketing, political science, sociology, insurance and many others.
It is about very complex analyse tool (Eisenhardt, 1989) in which it wants to be
explain complex relationships between agent (person who represent the prin-
cipal and act in the name of the principal) and principal (person who engage
the agent to manage the asset in the name of the principal). Agency costs arise
from behaviour in principal-agent relation where principal bears the costs of
monitoring the agent.
The situation where two parties negotiating about potential transaction do not
have the same information on the transaction value is called the status of asym-
metric information. Asymmetric informations are continually emerging in so-
ciety mainly due to the degree of general availability of information, but also
the degree of education. In economy and commerce, the process of creating
asymmetry in information can be viewed as a process that precedes a profita-
ble transaction. A person who has more information on the subject of exchange
will probably have a higher value added. When two groups are trading, the
more knowledgeable group will have more information that can lead to higher
productivity. This group will have a greater business value.
This is a positive example of asymmetric information. However, there are nu-
merous negative examples as a consequence of asymmetry in subject and way
of business. In the case where a person has information that could, in a case
reacheable to the opposite party, reduce the benefit or increase costs, that per-
son will conceal such information until the transaction is concluded in the man-
ner and under the conditions appropriate to the person hiding the information.
It is about manifesting the negative consequences of asymmetry in information
between two people in a potential business relationship - adverse selection.
According to the definition (Encyclopedia Britannica), adverse selection is a
case in which one person tries to conceal the information that, for her, might
negatively affect the final outcome of the transaction.
Examples are numerous and noticeable in many areas of life: selling of dispos-
able things (the seller has more information on the subject of the sale and tries
to discard it in order to achieve a higher sales value), insurance (the insured
has information on the likelihood of risky behavior he strives to insure to the in-
surer in order to achieve less (the candidate pursues only positive features and
knowledge to increase the likelihood of employment), finance (the manager
decides to finance new asset with shares in case the value of the share of the
company exceeds the real value). Behavior of entities in the circumstances of
adverse selection is a behavior before concluding a transaction or concluding
a contract. The second manifestation of negative effects of asymmetric situa-
tions is a moral hazard. According to the definition (Kunreuther, 2008; Auronen,
2003) it is a situation in which a person who is insured against certain risks
in the future is inclined to assume either or part of the risks that are secured

321
because any materialisation of the risk will produce costs on the other party,
insured parties for the reason of higher value of the cost of the materialized risk
in relation to the premium for the transferred risk.
There are numerous examples of moral hazard in different areas of life: in-
surance (the insured will be exposed to greater risk and activation of the in-
surance policy because the premium is paid less than the materialized risk),
employment (the employee will use the benefits less contractually regulated
by creating additional costs (to the employer), finance (the credit borrower will
be in a state of reduced ability to pay obligations based on a credit), trade (a
product buyer with inappropriate use of the product and caused damage will be
entitled to refund or replacement). According to Sungu (2005) in practice, the
relationship between principal and agent is not divided into two components,
respectively adverse selection and moral hazard. The theory, which attempts to
explain the complexity of the situation, describes separately these information
asymmetry effects. Adverse selection problems arise from information asym-
metry before and / or after contracting, while moral hazard problems stem from
the unobservability of managerial effort only after contracting
The effects of asymmetric information have been intensively investigated in
the business, especially the financial and insurance sector in the last 40 years.
The work of Stiglitz and Weissa (1983) is well known, which presents the appli-
cation of the conclusions of the asymmetric information theory in the financial
sector. Stiglitz and Weiss are investigating the effects of contracts with options
of suspended termination (possibility of termination of contract, contingency
contract) on the behavior of contracting parties that contribute to the reduc-
tion of adverse selection and moral hazard. For example, adverse selection,
that is, those who apply for the credit get riskier on average, and the incentive
effect, that is the ones applying credit have an incentive to spend it on riskier
projects (Stiglitz, Weiss, 1981). Samuelson (1984) investigates the effects of
asymmetric information in the bargaining process and concludes that it is useful
for the negotiating parties to engage the mediator if the costs of engaging the
mediator are lower than the potential agency costs. Hansen (1987) has come
up with similar conclusions regarding the mediator or broker, pointing out that
the selection of mediators in merger proceedings can reduce agency costs and
increase transaction success. Mattsson (2002), using the theory of asymmetric
information, explains the relationship between entrepreneurs and equity inves-
tors. Recently, with the theory of asymmetric information, the aim is to explain
and improve different solutions with subcontractors (Auronen, 2003).
Within the scope of this paper, special emphasis is placed on the use of asym-
metric information theory in the area of ​​application of project financing tech-
niques because the public authority chooses between two public procurement
models: traditional and alternative. When applying an alternative model, as a
private entrepreneur takes on the risks of design, construction, maintenance
and financing, he applies project financing techniques, thus creating agency
relationships between equity investors and managers, equity investors and

322
creditors, and management and long-term suppliers. Namely, Shah and Takor
(1987) provide asymmetric information and signalling theory in response to
questions about the capital structure in projects using project financing tech-
niques. Finerty (1996) argues that the choice of project financing techniques,
especially in public infrastructure projects, is result of higher probability of agen-
cy costs being reduced due to more effective management control by the own-
ers of managing the cash flow of the public project and reducing the risk of
underinvestment with parent companies already in charge of other projects.
Esty (2003) comes to similar conclusions, pointing out that the parent compa-
nies (SPV2 owners in project financing) increase their value precisely because
of the reduction of agency costs and the risk of underinvestment. Agency costs
arise because of asymmetric information between managers (who control pub-
lic investment and its cash flows), and entities that provide funding sources and
public investment (equity and debt holders). Certain property characteristics
can cause agency costs. Assets that generate high profit margins and high
EBITDA3 cause underperforming creative efforts and above-average earnings
(private benefit managers). Conflict arises in the decision on allocation of EBIT-
DA; whether the majority of available EBITDA will be reinvested or distributed
by sources of funding or reinvested. Project financing here solves the agency’s
conflict with the imperative of paying off excess money through funding sourc-
es, preventing reinvestment and limiting the duration of the project (contract).
Processes based on asymmetric information are, of course, also present in
the public sector. The main-agent problem arises in the public sector due to
the existence of public policies and its manifestation differs somewhat from the
private sector manifestation. Namely, there are claims (Lane, Ersson, 2003) on
the difference between the principal-agent problem in the public and private
sector due to the difference in the delivery of goods and services. In that sense,
the difference arises whether the agents are to allocate public goods (non-ex-
cludable, jointness) or whether they also supply private goods (excludability,
rivalry). It is also interesting that a public sector has a double principal-agent
interaction, first between electorate and politicians (political parties), then pol-
iticians and bureaucrats. Thus, principal-agent interaction in the public sector
could be more complex then in the private sector. Adverse selection in public
sector can be met when public authorities buy goods and services. Cox (1996)
stresses that public procurement can not be effective until the information
asymmetry has been reduced or eliminated. Adverse selection occurs when
the government accepts the bid of an inefficient producer because it can not
observe the bidders’ expected production costs before awarding the contract
(Cox et al. 1996 in Attila, G.)
Until now, in the literature, the agency problem is mainly referred to as a re-
lationship between the authority and the business organization that delivers
public services. However, he gets the impression that the agency problem with

2 Special Purpose Vehicle.

3 Earning Before Interest, Tax, Depreciation and Amortization.

323
his manifestations caused by asymmetric information such as adverse selec-
tion and moral hazard is also present in the relation between the voter and the
future mayor, in the relationship between the mayor and the administration and
in relation to the authority and the provider of public services.

3. Agency problem in public investment

In this paper attention is focused in two processes. First process is related to re-
lationship between taxpayers (voters) and political candidates in period before
they come in to power (new authority has been established) during the period of
democratic election within which political representatives presents their plans
for the investments in the case in which they would be selected.
This relationship is represented in Figure 1:

Figure 1. Relation between voters and candidates in the election process

Voters have less information regard candidates and budget (fiscal capacity)
then candidates have, so in this relationship exist significant asymmetry be-
tween information they have.
After the end of the election process, candidates become the official represent-
atives (authority) of the voters and, from that position, deliver promised public
investments and public services to the citizens (taxpayers). Authority finances
deliveries of public investments and services from taxes levied by taxpayers
(voters).
Relationship between taxpayers and authority after the election process is
shown in Figure 2:

324
Figure 2. Relation between taxpayers and authority after election process

The order and quality of delivered public services depends on information, fis-
cal capacity and authority preferences. After establishing the authority, the au-
thority coordinates the information on the fiscal capacity and develops its own
priority sequence of delivered public services and infrastructure. This (new)
priority list could be different than one in election process.
Taxpayers expect the value of public services adequate to the cash that with
the tax they pay into the budget. If the standard of public services is commensu-
rate with the money paid, it may be argued that the taxpayers, or the final users
of the services, receive a value equivalent to the money paid. However, the
value of public services may be less than the value of the money paid, which
results in a lower value received for paid money. Thus, the reduced standard
of public services compared to the payroll tax payers or final users results in a
lower value for money.
In relation to the authority and taxpayers (final users), the authority has much
more information than taxpayers about the possibilities of delivering public ser-
vices with the most common fiscal capacity and the priority delivery of new and
existing public services. This difference in information between the authority
and taxpayers is referred to as the status of asymmetric information resulting to
an agency problem in which the authority is agent and the taxpayer is principal.
In this situation, the principal carries the agency’s costs.
However, in this relationship is an interesting comparison of the behavior of
authority before and after the election process. Namely, the behavior of can-
didates (who came to power) before and after the elections may not be the
same. Specifically, the authority does not have to deliver the public services in
the order and quality as promised in the election process. In other words, the
authority can change the behavior in relation to the election process. By acting
rationally in the sense of staying in power, the authority can try to maximize the
delivery of the promised public investments, but due to limited fiscal capacity,
with a reduced public service standard. Payments of taxpayers remained un-
changed. Thus, taxpayers in these cases bear agency costs.

325
Agency problem’s second case can be found in the relationship between the
authority and the contractors of the works on the public infrastructure. This re-
lationship is shown on Figure 3:

Figure 3. Relation between authority and construction companies

Namely, for the purpose of delivering public services to the final users (taxpay-
ers) authority engages contractors for work in public infrastructure through the
intermediary of delivering public services to the final users. For example, a pub-
lic education service is provided through a built school, a public health-curing
service provider through built-up hospitals, a public transport service through
a built-up motorway or railroad, and the like. In the process of preparation and
final delivery of the project the authority is exposed to the risk of finishing the
infrastructure development consistent with the basic idea and the desire of the
authority, and later, after the conclusion of the contract, to execute the tasks in
accordance with the contract. In this relationship, the contractor has more infor-
mation on the subject of procurement, so he is in the role of the agent while the
authority is in the role of principal. Due to different information on the subject of
procurement, the authority will bear the costs of various types of surveillance in
order to reduce the asymmetry. This relationship also identifies the potentials
of changing the behaviour of the contractor after the contract is a moral hazard.

4. Possible instruments for reducing taxpayers agency costs

in public investment
In order to reduce the asymmetry of information between taxpayers and au-
thorities, on the one hand, the authority and project contractor on the other,
there are various instruments available to the entities, which could, by appro-
priate application, reduce agency costs and increase the value of the services
or works paid for.

4.1. Potential instruments for reducing the asymmetry of information

between taxpayers and authorities
The agency costs incurred by taxpayers (as principals) in relation to the author-
ity (as agent) are manifested in the form of impaired value of services received

326
in relation to the money paid (tax). In order to receive the value of the delivered
public services adequate to the money paid, the taxpayers will insist on defining
the standards of public services as well as payment mechanism. For example,
for an efficient and effective public education service, it is necessary to provide
adequate space through which public education services (school, classroom,
gymnasium etc.) will be delivered.
The construction of the school is funded from the taxpayer’s taxes. For the
paid ammount of tax, taxpayers have the right not to get any school build-
ing, but a school building that is energy efficient (reduced energy consumption
for achieved heating and lighting), effective (long term achievement of energy
standards, CO2 reduction, energy production and the like), thermally stable
(room temperature appropriate for activities, season and outdoor weather con-
ditions), illuminated according to the activities (classroom lighting, lighting in the
sports hall, lighting in halls and dressing rooms, and the like).
Certainly, a standard so defined must be delivered to the building’s whole life
(school), which brings the authority to the position of regular maintenance ob-
ligations, thereby balancing the benefits (delivered standards) and the costs
(paid taxes) of existing and future generations of taxpayers or final users of the
school. The relationship between taxpayers and authorities in the circumstanc-
es of reduced agency costs is shown in Figure 4:

Figure 4. Possible relationship between taxpayers and the authority in the case of
reduced agency costs.

It is about so-called building’s output specifications that can be continuously

and automatically measured, especially with the use of smart sensors, smart
contracts and IoT4 technology. The measured data, processed in information
about the delivered standards, can be the basis for evaluating the relationships

4 Internet of Things.

327
planned and realized. Thus, the authority is in a position to take over the risk of
delivering a certain (contracted) standard of public service for collected taxes
from taxpayers. Measured standard delivered in a transparent way, throughout
the lifetime of the building (school), all participants are informed about achiev-
ing adequate value for money. Such results will serve the authority as a set of
data for the purpose of correcting its activities and policies while serving tax-
payers as a real proof of the efficiency of their administration.

4.2. Potential instruments for reducing informational asymmetry

in authority – construction company relationship
The main assumption on Figure 4 is that the authority procures the works.
This means that a construction company will conclude a building contract (eg
school). It is a traditional procurement model (TPM) within which the authority,
after the built school, continues to maintain and manage the building itself (in
house). The basic feature of such a procurement model is that the authority
takes over a majority part of the school’s risk in its whole life. This further means
that the authority, with its administration, will be responsible to the taxpayers
for the delivery of defined school premises. At such a procurement model, the
authority decides when its administration is capable of managing all the risks
of such a project.
However, one should ask whether this is always the case for any type of public
service or public building? If the authority and its administration do not possess
the necessary knowledge and skills in managing overall project risks, the risk
of excessive and unexpected materialization of the risk is expressed, which will
result in suboptimal delivery of the standard and consequently lead to reduced
value for the taxpayer’s money. Also, the authority is exposed to the risk of in-
formation asymmetry and moral hazard. Namely, the construction company will
behave rationally and strive to win in the public procurement process. Since the
construction company has far more information on the subject of procurement,
it will seek through economics of built-in materials and building logistics to re-
duce the costs of construction, which will maximize the success of the bid if its
bid is competitive5. However, after the construction company supplies the build-
ing, it leaves the contract and the maintenance costs are left to the authority.
However, the authority can be protected from materializing such risks and
transferring these risks to the construction company. If the project documen-
tation is prepared professionally and in accordance with good world practice,
the authority may successfully transfer the design, construction, maintenance,
financing and operational risk to the construction company by applying an alter-
native procurement model. The relationship between authority and construction
company when applying an alternative procurement model (APM) is shown in
Figure 5:

5 This costs could be reduced if the open public procurement procedure is replaced with compet-
itive dialog.

328
Figure 5. Possible instrument for reducing agency costs in authority – construction
company relationship

Applying the APM authority no longer acquires the building (school) but the
schoolroom conditions it needs to deliver the basic public service: education.
Construction company will build the school, finance the construction and main-
tain it in accordance with agreed standards. As long as construction company
supplies space requirements in accordance with agreed standards, the author-
ity will pay unitary charge. In the case of delivery of reduced space conditions,
according to payment mechanism, the authority will reduce the fee. This pay-
ment mechanism solely to the standard delivered is directly related to the pres-
ervation of value for the taxpayers money.
Economic theory suggests that, in the presence of positive externalities, asym-
metric information problems and lack of contractibility of quality dimensions,
alternative procurement models can result in better-quality infrastructures and
services and in lower whole-life costs than traditional procurement (Iossa, Sau-
ssier, 2018).

5. Conclusion and further research

Complex relations between taxpayers, authority and construction companies
are continuously exposed to asymmetry in information and interests. Because
of this asymmetry, the participants in each other’s relationships have certain
costs depending on the role of the agent and principals. Economic theory and
practice seek to understand these relationships and to propose instruments
for reducing agency costs. In this paper they are particularly prominent the
relations between the taxpayers and the authority (the relationship between the
taxpayers in the role of principal and the authority in the role of the agent) and
the authority and the construction company (relationship in which the authority
is in the role of principal and a construction company acting as an agent).

329
This problem is seen from the aspect of the development of culture and the
practice of defining public service’s standards (soft and hard) and their per-
manent measurement and comparison of planned standards with realized us-
ing smart city technologies and applied alternative procurement models, within
which the authority is no longer focused on the owning of public buildings and
procurement of works but the focus is diverted to the availability of public build-
ings and the role of supervisors of the standards delivered. The main benefit
of the authority using this position came from transferring the project’s risks to
construction company not with procuring building but already providing availa-
bility of building.
This change in the role of authority and appropriate preparation of documenta-
tion in accordance with good world practice could create the potential to reduce
the agency costs of all participants in the project, increase value for taxpayers’
and end users’ money, increase end users satisfaction, and work and efficiency
of public administration to quantify in the purpose of a better election process.
Academia and policy makers should promote more information sharing among
administrations and the use of model tenders (standardized tenders) and mod-
el contracts (standard contracts) to improve the tendering and contracting of
administrations. Open data and open government would also facilitate learn-
ing and accountability, paving the way for more efficient and effective alter-
native procurement models such as PPPs, concessions and the like (Iossa,
Suissier, 2018).

330
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 CHAPTER 20

The Impact of Internet of Things (IoT) and Digital

Transformation on Smart Environments
and Integrated Ecosystems

Milos Loncar1

ABSTRACT

The research investigated the potential influence of IoT as well as digital transformation on
building smart environments such as smart cities and smart workplaces along with inte-
grated ecosystems. The research described how successfully technological developments
through Internet of Things have contributed in developing smart environment. It pinpointed
the technologies like sensors, vision processing and application-oriented approach for
human central thinking. The research highlighted various types of smart environments
that were created due to technological developments of the IoT through technologies like
robotics, HCI, computer networking techniques, mobile devices, collaborative thinking and
computing. The research adopted qualitative methods of data collection, analysis and ob-
servation for the interpretation of results and indicated that IoT has made significant influ-
ence on building technologically developed smart environments. It explored that Internet
of Things have contributed greatly in development smart environments to improve living
and working of people at technologically developed living and workplace environments.
It has improved the living of the people through communication and interaction modals
with humans, practical design solutions and multi-faceted conceptual development and
algorithmic considerations of the seamless business operations.

Key words: Smart environments, integrated ecosystems, Internet of Things,

Improved living and information sharing, technology
developments

JEL classification: Q57

1. Introduction
1.1. Introduction
The current research identifies the importance of IoT & digital transformation
that contributes greatly in building smart environments and highly developed
and integrated ecosystems. It describes the services of IoT in making the en-
vironments healthier due to latest technological developments. It presents how

1 PhD research candidate, University of Belgrade, Faculty of Organizational Sciences, Jove Ilića
154, 11000 Belgrade, Serbia. Global Black Belt IoT Solution Professional, Microsoft Corporation
Phone: +4368181109100 E-mail: milos.loncar@hotmail.com.

333
successfully IoT has enabled physical world to adopt actuators, sensors and
computational elements to maintain continuous work connectivity. When the
physical environments are effectively interconnected through latest technolo-
gies and computational elements, they form a smart environment and contrib-
ute greatly in providing healthy living environment to their residents. A smart
environment is highly essential to provide necessary support to the residents
of a region by improving their abilities to execute health tasks. The research
examines how successfully these environments facilitate the living of people by
investing their potential influence of IoT-based smart environments on common
people. The IoT-based these environments and ecosystems provided techno-
logically developed solutions such as enhanced communication networks, lo-
cal area wireless standards and characteristics. IoT-based smart environments
and ecosystems have brought about new opportunities for people to make
positive and healthy effects on their living (Ahmed et al., 2016). The research
highlights that smart environments with integrated ecosystems could contribute
greatly to promote the participation of different communities to adopt several
enabling technologies to improve their living through multi-modal sensing, vi-
sion processing, application-oriented approach for human-central thinking. The
smart environments also contribute through robotics, HCI, networking, mobile,
collaborative thinking and pervasive computing. Therefore, smart environments
are developed through IoT and digital transformation and contribute greatly
in serving and developing interaction modals with humans, practical design
solutions and multi-faceted conceptual developments as well as algorithmic
considerations for seamless operations (Ashton, 2009).
The research highlights interconnected smart world where humans are con-
nected with devices due to smart environments. The exchange of data has
become easier for better decision making due to better environments and
ecosystems. The increased utilization of internet has provided us great op-
portunity to continuously adopt and use computer networks as smart devices,
phones, people and communities. A digitally developed and well connected
ecosystem was developed based on different layers of data including the layer
representing communication between people or entertainment and the virtual
life in second layer where human and objects were interconnected to a local
network. The technological developments based on Internet of Things and dig-
ital transformation has contributed greatly in offering seamless connectivity to
people with smart devices and objectives to improve their living. The research
determines how successfully these environments and ecosystems through in-
tegrated mechanism are developed by adopting latest technologies such as
small ubiquitous devices like sensors, RFID tags, actuators, smart phones and
the embedded ecosystems. But, these networks and devices are associated
with some challenges or discrepancies due to their narrowing capabilities in
resources. The research also addresses that issues to ensure IoT and digital
transformation has helped us to overcome these issues and to improve the
connectivity of smart objects to local networks under the latest technological
developments in IT (Petroulakis, Askoxylakis & Tryfonas, 2012).

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1.2. Background of the Research
The research conducted by Petroulakis, Askoxylakis & Tryfonas (2012) pointed
out that Internet of Things has contributed greatly to develop smart cities and
smart workplaces through IoT in technologically developed environments. The
modern-day ecosystems and interconnected devices with local networks have
created smart environments by improving the capabilities of devices, building,
places and people. It improved internal and external interfaces of the technol-
ogies with these devices, buildings and people by developing smart cities. The
research highlights that Internet of Things has become essential in developing
Smart Planet as well as connectedness among communities through smart
devices and communication solutions. The author pointed out the important
elements of the smart environment such as smart objects that interact with
the environment and make it worthwhile for living. The second important com-
ponent of smart environment was based on the interconnection between the
smart objects and the local networks that promote communication and inte-
grated ecosystems. According to the information presented in the research,
the life-logging was the third important component of smart environments that
showed its interrelationship with the smart environment (Rajguru, Kinhekar &
Pati, 2015). The structure of the these environments and ecosystems was high-
lighted in the figure given below;

Figure 1. Smart ecosystems

The research conducted by Vermesan & Friess (2014) examined IoT by iden-
tifying their influence to converge latest technologies into smart environments
and highly integrated and developed ecosystems. The authors pointed out that
IoT is interconnected with several combinations that are essential for the growth
of smart environments through smart devices including computational, wireless
and data storage devices in the real world. These technological developments

335
have provided greater chances to the organizations to overcome their major
challenges to ensure these environments by overcoming interoperable technol-
ogies and standards, information and data management issues, their privacy
and security concerns and skills needed to manage the complexity of growing
IoT in the technologically developed organizations. The research highlighted
that the management of organizations is responsible to take holistic view of
their IoT approach to examine opportunities it offers and challenges it address-
es through these environments. IoT has found to be responsible to build strong
business cases to enhance revenues with increased market share, profitability
and increased efficiency of the businesses. It has also increased the competi-
tiveness of the businesses by improving their asset management and making
them compatible with associated environments (Cognizant, 2014). The man-
agement of fast growing highly competitive organizations is also responsible
to master their skills in IoT to identify business operations or areas of concerns
where IoT-based smart systems could be implemented and significant benefits
could be achieved. The development of robust data along within technologi-
cally developed environments & ecosystems has become very crucial for the
businesses to mine valuable insights in the process of generating data by im-
portant business transactions and interactions that could happen through the
IoT integrated ecosystems. The information that surrounds people, businesses,
their operations, processes and products and services is always important to
be protected through integrated databases. Code information could be effec-
tively used in managing IoT-based environments & ecosystems that generate
data for the development of improving business cases, training skilled talent
and achieving their desired goals and objectives. The research pointed out
that IoT-based environments and ecosystems could be associated with several
technologies and devices that could be adopted through the interconnectivity of
different networks (Jerald, Rabara & Bai, 2015).

1.3. Research Aims and Objectives

The main aims and objectives of the research are based on following points:
• To investigate how effectively IoT could make significant influence on en-
vironments to make them smart environment associated with ecosystems
• To examine various tools and techniques in the context of IoT that could
enable the businesses to work in smart industries and smart business
environments
• To determine how IoT has transformed the rapid convergence of infor-
mation and communication through Cloud, data and communication
networks by ensuring smart environments and ecosystems in business
environments
• To explore how successfully IoT and digital transformation address smart
environments by transferring physical business activities into digital
activities

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 • To evaluate how successfully IoT strategies and innovation directions
ensures these environments & ecosystems due to latest technological
developments
• To describe how successfully IoT and digital transformation has enabled
the businesses to adopt automated, self-controlled and innovative busi-
ness solutions through built-in fault detection and diagnostic capabilities
to ensure smart environments and ecosystems in which they work

1.4. Importance of the Research

The research examined the influence of latest technological developments
like IoT & digital transformation on developing smart environments that are
highly important for businesses that work in highly competitive business envi-
ronments. Internet of Things has enabled the business organizations to adopt
latest technological solutions to address their business requirements in these
environments to provide notifications, save energy, ensure safety and security
of their products and services, production processes, and highly interconnected
ecosystems with shared interface. The research paper is highly important in
addressing the business concerns to adopt latest technologies to enhance in-
tegrated communications through these smart environments and ecosystems.
These technologies would enable the businesses to improve their business
performance through Internet of Things including sensor networks, M2M, RFID,
integration of semantic data, semantic search and IPv6 etc. The technologies
such as Cloud computing, virtualization of the networks and embedded sys-
tems would be helpful for the businesses to enhance their capability to be con-
nected all the times everywhere (Jerald, Rabara & Bai, 2015).
The current research on identifying the influence of IoT on smart environments
and ecosystem indicates that these systems including hardware and software
integrate growing community of commercial and consumer IoT users. It en-
abled the businesses to save their business data through IoT data security,
protect personal privacy and intellectual property and encourage interoperabil-
ity among IoT-based devices and systems. The application of IoT and digital
transformation in creating smart environment & ecosystems has made potential
influence on changing the lifestyle of people. Now people can adopt techno-
logically developed tools and techniques to live a healthy environment with in-
creased fitness to avoid diseases and living a healthy life. The application of IoT
to businesses in creating technologically developed environments & ecosys-
tems have benefited businesses and human assets significantly by reducing
communication time, saving money and creating greater value for consumers
by designing technologically developed products and services meeting their
desired expectations. Overall, the latest technological developments like IoT
& digital transformation has contributed greatly in building the trust of the cus-
tomers on their products and services by developing new business models and
bases of competition for them (Nguyen & De Cremer, 2016).

337
2. Literature review
2.1. Review of the Literature
The research work conducted by Vermesan & Friess (2013) investigated the
conversion of latest technologies on building smart environments for better pro-
ductivity and enhanced performance at the industrial level. IoT in developing
these environments has become central point among majority of governments
in Europe and Asian countries. Large numbers of businesses has given nec-
essary attention to the IoT with added additional components to improve the
associated business environments and ecosystems. The authors pointed out
that businesses operating in the private sectors and their end-users are opting
for significant components of IoT to deal with smart devices and networked
applications. It has continued to develop and has the potential to combine rel-
evant technologies all together such as the technologies of Cloud, Big Data,
Semantics, robotics and Future Internet. When the technologies associated
with the IoT are better exploited, they work for a stronger cross-domain in-
teractivity, increased awareness of the businesses about problem-solving and
achieving better productivity and competitiveness in comparison to other mar-
ket players. The authors highlighted that time for conversion has arrived and
the businesses could take up smartphone platforms or user-driven applications
that could run on multiple level through the successful connectivity of various
sensors and the objects (Kortuem et al., 2010). The increased use of latest
technologies in the IoT could bring together a number of distinct constituencies
to develop integrated ecosystems. IoT has revolutionized the world by provid-
ing technological developed solutions to their business problems to adopt in-
novation, creativity and integration of their business processes with associated
external environments through digitally connected solutions. It has provided
huge variety of solutions to the business enterprises to actuate and sense their
capabilities, process information and adopt generally apprehend objects as en-
tities with a growing intelligence and patterns of autonomous behaviors. It has
increased the interactivity of the coherent applications by reducing the com-
plexity and modulation and boundaries between the applications and services.
The IoT has enhanced the coherence between the real world and the virtual
worlds by facilitating the businesses to store big amounts of data at their da-
tabase and increase networks and information processing capabilities (Jones,
Suoranta & Rowley, 2013).
Sniderman, Mahto and Cotteleer (2016) pointed out how effectively modern
enterprises can adopt latest technologies to improve their productivity and
business performance through technologically developed environments &
ecosystems. IoT has contributed greatly in getting increased connectivity of
manufacturing organizations by getting more sophisticated data collection and
enhanced analytical capabilities of the businesses to shift their focus towards
information-based economy. The research also highlighted that increased use
of latest technologies such as technology related to industry 4.0 could be ef-
fectively used by the management of industrial organizations to reduce their

338
business risks and to enhance their productivity. These technologies with IoT
have helped the management to effectively plan their business processes, pre-
dict changes and respond to business changes in real time. Effective plan-
ning at production processes was observed to be helpful for the operational
managers and manufacturers to overcome uncertainties and risks across their
manufacturing processes. Large numbers of businesses in the industrial sec-
tors have adopted IoT as their major technological developments to ensure
their manufacturing and production processes have achieved smart environ-
ments with integrated ecosystems. The business performance has also been
increased due to the applications of digital technologies to operate effectively
in the industrial environments by adopting augmented reality, controls, sensors
and wearables at the industrial level. The Industry 4.0 technologies have been
developed through the utilization of IoT for smart environment and integrated
ecosystems to enhance labor productivity and effectiveness and ensure suc-
cessful achievement of business goals and objectives for their management
(Jones, Suoranta & Rowley, 2013).
It has successfully automated the scaling of manufacturing processes aftermar-
ket operations. According to this facility, when a product is developed according
to the requirements and expectations of the clients, it is shipped and sold out
to the clients where Industry 4.0 technology supports the management in three
major areas. The management of various businesses in the industrial sectors
has adopted IoT for smart environments through IT/OT applications to ensure
productivity of the businesses. It contributes greatly for asset intelligence and
effective industrial productivity to improve the confidence of employees at com-
petitive business environment. Therefore, the research explored that increased
use of IoT has enabled the management of various industrial units to effectively
manage talent and workforce, data ownership and control, ensure standards
and interoperability, and improve security and business performance by de-
veloping smart workplace environments. Overall, the research work conduct-
ed by Sniderman, Mahto and Cotteleer pointed out that increased use of IoT
could be helpful for the management of businesses to ensure effective flow
of information to ensure business growth and operational competitiveness. It
could be transformed into enhanced satisfaction of the major stakeholders of
the business such as business directors, investors, suppliers and customers.
The effective implementation of Industry 4.0 technology with the help of IoT
has enabled the businesses to get clear understanding of the ways by which
physical activities of the business could be transformed into digital activities to
achieve their long-lasting business goals (Bi, Xu & Wang, 2014).
Patel and Patel (2016) investigated the potential impacts of IoT on smart envi-
ronments by indicating that the development of these technologies has enabled
the organizations to compete well, increase their market share, produce innova-
tive products and services for their clients and address future business-related
challenges successfully. The constant application of this technological devel-
opment to business processes has enabled the businesses to acquire contex-
tual information successfully, process it and improve their security and privacy.

339
The IoT has contributed greatly in developing smart devices to enhance the
interconnection of physical and digital worlds to allow the businesses to have
real-time information to be successfully collected and processed. The business
owners and managers could be various types of sensors for different purposes
to take the measurements of the associated temperature, air quality, humidi-
ty, speed, pressure, flow, electricity and movement. The IoT has enabled the
businesses to use gateways and networks to improve their business perfor-
mance by using robust and high performing wireless network infrastructures.
The businesses could meet their customer requirements by executing latest
technological solutions based on IoT services and applications for high speed
business transactions and context-aware applications. Large numbers of busi-
ness organizations have been found adopting IoT for organizational interopera-
bility to ensure effective communication and data transfer by adopting a variety
of information systems over widely used different infrastructures across differ-
ent regions and cultures. Overall, this technological development has enabled
the management of fast growing and competitive business organizations to
work in a fully interoperable environment by using IoT devices to enable them
to connect with other devices or systems and exchange or share information
successfully. Varying degrees and different layers were used for ensuring inter-
operability among IoT devices to ensure the required business environments &
ecosystems in which businesses operate and produce products and services
for their customers. When the businesses are physically and digitally intercon-
nected and exchange of data is ensured through multiple systems across a
variety of networks, businesses succeed in achieving their smart workplace en-
vironments and working in interconnected ecosystems (Bi, Xu & Wang, 2014).

3. Research methodology
3.1. Explanation and Justification of Research Methodology
The research methodology in the context of current research on smart environ-
ments along with integrated ecosystems could be defined as the process by
which necessary information on IoT, digital transformation and their influence
on smart environments and ecosystems be collected to make better decisions
in adopting latest technologies for business competitiveness. The research
methods could be adopted according to the requirements of the research to
prove theories depending upon exploratory, descriptive or explanatory methods
to be used for the purpose of data collection. The research has investigated
how successfully latest technologies have improved in the form of IoT and dig-
ital transformation and contributed for the technologically developed environ-
ments and ecosystems.

3.2. Exploratory Research

The exploratory research is defined as the process that could be effectively
used in the current research to define the initial hypothesis or theoretical idea

340
and it is explored in social science research. In the current research, the ideas
of IoT, digital transformation and their influence on environments and ecosys-
tems have been discussed to elaborate their significance in the form of smart
environments as well as ecosystems. It attempts to determine the potential in-
fluence or impacts of IoT on smart environments and integrated ecosystems. In
order to get in-depth information and data on possible influence of IoT on smart
environments and ecosystems, the research attempts to laydown necessary
foundations to observe and explain the relevance of the study through existing
theoretical content on the relevant technological developments in the industry.

3.3. Research Design

A good research design is always essential for a social science research to ex-
plore the impact of independent variable on dependent variables. It describes
the research framework that a researcher could adopt by describing detailed
processes and procedures of getting necessary information to solve the re-
search problems and to achieve desired research goals (Driscoll, 2011). The
research design is selected with an objective whether to adopt exploratory or
explanatory design studies to the potential influence of latest technological de-
velopments of the smart environments as well as technologically integrated
ecosystems. The exploratory research is only concerned with the qualitative
methods of data collection, analysis and observation on the given topics in the
areas of social science.

3.4. Research Methods

The current research will examine the research methods based on qualitative
as well as quantitative methods of data collection, analysis and observation to
achieve the desired outcomes of the research. The qualitative research is as-
sociated with theoretical or non-numerical data and it is concerned in gathering
the verbal information either through the research work of other researchers or
through primary sources of data collection. It examines the data without numer-
ical measurements and gathers the information without doing any analysis in
the interpretation of results in more subjective, impressionistic or even in the di-
agnostic manner. The primary objective of selecting qualitative research meth-
od is concerned in providing complete and detailed description of the research
while quantitative research method provides statistical inferential techniques
to gather analyze and predict the accuracy of the information. Qualitative re-
search in the context of current research is ideal.

3.5. Research Strategy

The research strategy is focused to adopt deductive research approach to gath-
er necessary information from the respondents regarding smart environments
and smart ecosystems and to examine their relationship with the technologi-
cal developments of the latest technologies. The deductive approach is highly

341
focused to investigate theories on given topic to observe their contribution in
the areas of technological development and smart environments. The research
strategy is guided according to the research aims and objectives to investigate
the impacts of IoT on smart environments and ecosystems at industrial organ-
izations. In developing the research strategy, it examines the extent of existing
knowledge, the amount of time involved in doing the research and using avail-
able resources strategically in accordance with philosophical assumptions of
the research. The strategy also evaluates the data collection methods through
surveys, interviews and published sources to examine the contribution of rele-
vant research topics in the areas of technological and industrial development.

3.6. Research Ethics

The principles of ethics and morality are highly important in conducting the re-
search on current topic to ensure that the information collected, shared and dis-
tributed based on legal and ethical grounds. The information selected qualita-
tively or quantitatively about the impacts of IoT on creating smart environments
& ecosystems that will be kept highly confidential. The research will also avoid
adopting ethical and moral grounds to observe the impacts of IoT on smart en-
vironments to contribute greatly to enhance public welfare by avoiding unnec-
essary physical and mental sufferings of the people. The research observed
two important types of implications of the research including psychological and
social implications through the breach of confidentiality.

4. Analysis and discussions

The current research was conducted to examine the potential influence of the
IoT on establishing smart technological environments along with integrated
ecosystems to achieve improved results for the businesses. It examined differ-
ent technological solutions that the management of businesses could execute
to enhance the performance and productivity of their business by integrating
their business operations to smart environments and technologically developed
integrated ecosystems. The research paper investigated how successfully IoT
has transformed in the past decades due to rapid convergence of the informa-
tion and communication through Cloud, data integration and communication
networks into technologically developed smart environments. It highlighted
the strategies that businesses have adopted to convert their businesses from
physical environments into smart technologically developed environments with
enhanced business performance and productivity. It evaluated the successful
strategies of the technologically developed business solutions in providing in-
novative directions to the businesses to succeed in achieving their business
goals and objectives. In evaluating the aims and objectives of the research, it
described how successfully IoT and digital technologies have enabled the busi-
nesses to adopt automated self-controlled and innovative business solutions
by setting up in-built fault detection and diagnostic capabilities in developing

342
smart environments to improve their business performance and productivity
(Ou et al., 2012).
The research pointed out that rapid convergence of information and commu-
nication through latest technological solutions such as Cloud computing and
communication networks has contributed greatly in developing or transforming
the physical business activities into digital business activities in the form of
technologically developed smart business environments. These environments
have become the center of successful developing of technologically developed
platforms. It enabled them to continue their business operations by adopting
multidisciplinary user-driven applications by connecting various sensors and
objects (Wang et al., 2012). These technologically driven super-stack environ-
ments in the digital world have contributed greatly to improve the level of com-
munication and information sharing within the business operations. The latest
technological development has performed wonderfully well to enable things to
be connected in a digital environment anywhere anytime and anyone would be
able to ideally use it through a service network. IoT along with digital transfor-
mation has revolutionized the world and objects could be integrated digitally
to make better organizational decisions through effective information sharing.
People connected through digital & smart business environments could enjoy
greater access to the business information aggregated by highly complex busi-
ness services (Porter & Heppelmann, 2014).
The research results obtained from already published indicated that latest tech-
nological developments have been transformed into technology-driven smart
environments & highly integrated ecosystems by transmitting broad range of
data at one place to help the businesses to create better products and servic-
es for their customers in competitive industry. The platforms of transformative
technologies have been used to enhance the integration and connectivity of
physical objects into digital objects by using Cloud and other technological de-
velopments in the industry. The Cloud technology has enabled the businesses
to develop an effective business infrastructure at global level to generate new
services by allowing their users to create content for global application users
(Jaykumar & Blessy, 2014). The research results showed that IoT along with
digital technologies has improved the access of the users to global network of
things. These technologies have created new opportunities to the businesses
and their customers to create new content and generate and purchase new
business services online. The integrated networks have enhanced the busi-
ness activities into positive direction by allowing different things to integrate and
to become more valuable in generating better services. The IoT has enabled
different technologies to integrate into productive ecosystems through sensor
networks, M2M, RFID, mobile internet connections, semantic data integration
and the semantic search engines. These networks were grouped into three
important categories and contributed greatly in acquiring new technologies to
enable things to get contextual information, to process contextual information
and to improve the security and privacy of the information (Zanella et al., 2014).

343
Figure 2. Smart environments through convergence of technologies

The research pointed out technologies associated with the IoT has enabled the
businesses to work in smart environments with considerable improvements in
business processes and operations. The results gathered, collected and ana-
lyzed from already published sources described that IoT has presented the
environment in which physical items were connected with the digital ones and
served the customers digitally with improved business services than before.
New technologies were used to control these things remotely with the help of
latest technologies like IoT where users can access anything anywhere through
smart digital environments as well as technologically integrated ecosystems.
The latest technology developments have contributed greatly in supporting the
users to get huge opportunity of economy and individualism with better and
more productive scientifically developed services. The technology improve-
ment in the communication and information sharing has enabled the business-
es to serve more effectively to their customers through sensors or built-in de-
vices to ensure enhanced interaction among people all over the world (Wang
et al., 2012). The scope and applications of the IoT were further expanded
over the passage of time and helped the businesses and their management to
adopt digital business solutions rather than concentrating on physical solutions.
It helped the businesses to succeed and to grow effectively efficiently without
any delays in the free transportation services due to worldwide applications of
the global delivery systems. It helped the societies to build smart buildings that
were much better than past physical infrastructures through controlled energy,

344
security, health and wellness. These environments were further developed in
the forms of smart watches, phones and personalized inputs that optimized
and enhance the benefits for common people in the society (Jaykumar &
Blessy, 2014).

Figure 3. IOT-based smart environments (Ahmed et al., 2016, p. 2).

The research results also indicated that latest technological developments in

the form of IoT have transformed in greater information sharing through conver-
gence of technologies like Cloud and communication networks. The rapid ad-
vancement of these communication networks have enabled the physical world
to integrate with the digital world through sensors, cloud, or other communi-
cation networks. The continuous connectivity of the physical objects into the
computational elements has formed smart environments. These environments
supported the dwellers to perform exciting tasks by navigating the unfamiliar
space and movements to the heavy objects for the elderly people (Perumal et
al., 2014). The research results pointed out the development of technology in
the IoT has contributed greatly in converging the information and communica-
tion into smart environments through Cloud, data and information sharing. It
has facilitated our lives by enabling IoT-based smart environments to improve
our living through network types, technologies, local areas wireless standards
and objectives and characteristics. The research also explored that the de-
velopment of latest technologies into smart business environments have ena-
bled the business to adopt automated, self-controlled and innovative business
solutions through built-in fault detection system and diagnosing capabilities to
ensure smart environments in which they work (Kim & Lee, 2015).

345
The current research explored that these technological developments in the
form of IoT has contributed greatly to create smart environments in the form
of smart transportation, smart cities, smart building, smart rural areas, smart
health and smart living. At the cities level, effective integration of technology
and data has led to highly coordinated and effective civil response to the securi-
ty and safety of their users. At the building levels, the smart environments were
developed for the end-users by leveraging technology into multiple applications
such as HR application, customer behavior in retail application and attendance
application etc. An increase in the development of smart vehicles has also been
experienced where infrastructure was effectively interconnected with the ob-
jects or materials. Similarly, auto manufacturers have started adopting smart
materials for their users due to technological developments (Ahmed et al.,
2016). The development of smart environment were only possible due to IoT
that were associated with optimized resources by providing different benefits to
the end-users such as traffic congestion was reduced due to smart cities, faster
services for travel were possible at various destinations and increased acces-
sibility of essential services became possible. Intelligent security systems were
developed into smart cities where markets and applications showed continu-
ous evolution and therefore, their economic potential made significant influence
in addressing the societal trends and challenges for the next decades. The
technologically developed environments and ecosystems contributed further to
improve the health and wellness of the people, transport and mobility improve-
ments, energy and environment, communication and e-society was developed.
These trends indicated that enhanced opportunities were created for markets
and their consumers in consumer electronics, automotive electronics, medical
appliances, information technology and communication (Gaikwad, 2016).

5. Conclusion
The main objective of conducting this research was to investigate how suc-
cessfully latest technological developments in the form of IoT have contributed
greatly in building smart environments for better productivity and services in
the form of smart homes, smart cities and smart workplace environments. It
examined how successfully physical work practices are integrated or convert-
ed to digital environments through latest technological devices. The research
highlighted the importance of smart environments to improve the living and
working of the end-users. It examined how successfully digitally created smart
environments enhance communication, information sharing and improvement
of services. The technology-driven smart environments along with highly devel-
oped and integrated ecosystems have created new business and living oppor-
tunities for users by making positive healthy effects on their living (Ahmed et
al., 2016). The research pointed out that smart environments have contributed
greatly in promoting the increased participation of communities through latest
technologies that enabled increased communication and information sharing
through multi-modal sensors, vision processing, application-oriented approach

346
for human-central thinking. The research explored how successfully smart envi-
ronments could contribute their part through latest technological developments
such as robotics, HCI, networking, mobile devices, collaborative thinking and
pervasive computing (Jones, Suoranta & Rowley, 2013).
In conducting the current research, the qualitative methods of data collection,
observation and analysis were investigated by analyzing already published
books, journals and online materials. The in-depth analysis of qualitative data
indicated that the contribution and impacts of IoT on developing technologically
developed environments and ecosystems are phenomenal and could never
be overruled in the recent years. It described that Internet of Things and dig-
ital transformation has contributed greatly in developing smart environments
such as smart homes, smart cities, smart workplaces and smart organizations
through well-developed and integrated ecosystems. The newly developed
smart environments and ecosystems have contributed greatly in improving the
levels of communication and interaction modals with humans, practical design
solution and multi-faceted conceptual development as well as algorithmic con-
siderations for seamless operations (Ashton, 2009).

347
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 PART 6

ORGANIZATION: ISSUES AND CHALLENGES IN

DIGITAL AREA / DIGITAL PUBLIC ADMINISTRATION
AND ACCOUNTING
 CHAPTER 21

Social Media: Towards open government

Dražena Gašpar1, Mirela Mabić2

ABSTRACT

An open government paradigm is based on transparency (public access to information

about the work of the government), participation (citizen engagement in the creation of
social policies) and collaboration (partnership and cooperation with citizens and private
organizations). The use of social media (Facebook, Twitter, YouTube) has potential to
increase visibility and transparency of the work of government and to ensure commu-
nication channel for the idea and information exchange between government and citi-
zen, making the process of creating policies more inclusive and increasing confidence
between government and citizens. The goal of the paper is to explore and compare
presence and activity on social media in those Western Balkans countries that were
belonging to one state in the past (Bosnia and Herzegovina, Kosovo, Montenegro, Ser-
bia and the former Yugoslav Republic of Macedonia). These countries were chosen
because of a similar level of economic development and reforms in government institu-
tions. The content analysis of their governments’ websites was conducted, together with
an analysis of links to social media platforms. The results show that these governments
have links to social media on their websites, with Twitter and Facebook as the most
used platforms. The frequency and the content of posts significantly vary from country
to country, as well as the activities of citizens. Although chosen countries accept social
media as a communication channel, there is still missing two-way communication with
citizens. The governments mostly publish promotional information about their work, and
the consequence is a relatively small number of friends/followers/subscribers and com-
ments/shares/likes on social media.

Key words: Social media, Open Government, Facebook, Twitter

JEL classification: H7, L86

1. Introduction
With an emerging development of Web 2.0 technologies, specifically social
media, a significant shift in everyday usage of technology happened. Kaplan
and Haenlein define social media as “a group of Internet-based applications

1 Full-time professor, University of Mostar, Faculty of Economics, Matice Hrvatske bb, 88000 Mo-
star, Bosnia and Herzegovina. Scientific affiliation: IEEE (Institute of Electrical and Electronics En-
gineers). Phone: +387 36 355100. E-mail: drazena.gaspar@ef.sum.ba.
2 Senior instructor, University of Mostar, Faculty of Economics, Matice Hrvatske bb, 88000 Mostar,
Bosnia and Herzegovina. Phone: +387 36 355100. E-mail: mirela.mabic@ef.sum.ba.

353
that build on the ideological and technological foundations of Web 2.0, and
that allow the creation and exchange of User Generated Content” (Kaplan and
Haenlein, 2010: 61). As most of the authors stressed, social media significantly
changed the way how people communicate to each other (Kietzmann et al.,
2011; Solomon and Schrum, 2010; Song, 2010) by allowing them to actively
design content through cooperative participation and permanent connection
(Wirtz et al., 2014). Kaplan and Haenlein (2010) defined the following social
media categories: blogs, collaborative projects, social networking sites, content
communities, virtual social worlds and virtual game worlds.
For the needs of presented research, the authors decided to analyze only social
networking sites (SNSs) because they are used by all governments of Western
Balkan Countries (WBC). As a web-based services, SNSs enable individuals
creation of their a public or semi-public profile within a bounded system, crea-
tion of a list of users (friends) with whom they want to share a connection and to
view and traverse their list of connections and those made by others within the
system (Boyd and Ellison, 2007). They are social media tools designed to facil-
itate the creation and maintenance of social relations. Today, some of the most
popular social network sites are Facebook, Twitter, LinkedIn, and Google+.
Since social media offer the richness of interactions, they are fostering the
involvement at the individual level providing potential for true collaboration
(Srivastava, 2016). Governments and public agencies recognized the potential
of social media and started to use them around 2009 (Klang and Nolin, 2011).
Since then, they have tried to harness social media’s potential for public pur-
poses and the fulfillment of the open government promises (Gunawong, 2015).
Although there is an overall agreement that former USA president Obama with
his Memorandum on Transparency and Open Government directing the imple-
mentation of Open government plans by federal agencies (Orszag, 2009) and
had huge merit in the popularization of the term open government, the concept
itself is not new. The first written references dates back to 1957 when Parks
(1957) published “The open government principle: applying the right to know
under the Constitution.” Later, in the 1970s, the British government promoted
several initiatives aimed at achieving more information freedom and more ac-
cess to government’s activity and, therefore, at reducing opacity (Chapman and
Hunt, 2006).
In 2010 the European Commission (EC) Directorate General for Communications
Networks, Content and Technology (DG CONNECT) launched the Digital Agenda
for Europe (European Commission, 2014) with the aim to support the open gov-
ernment initiative and to foster citizen participation and engagement by getting
the most of digital technologies, particularly social media (Karakiza, 2015).
The political instruments for implementation of the Digital Agenda are the
eGovernment Action Plans which should advance the modernization of public
administrations across the European Union. The Digital Single Market Strategy
for Europe (DSM) announces the launch of a new eGovernment Action Plan

354
for 2016-2020. The main purpose of a new Plan is to remove existing digital
barriers to the Digital Single Market and to prevent further fragmentation arising
in the context of the modernization of public administrations. The final goal is
that by 2020, public administrations and public institutions in the European Un-
ion should be open, efficient and inclusive, providing borderless, personalized,
user-friendly, end-to-end digital public services to all citizens and businesses in
the EU (European Commission, 2016).
While OECD defines Open Government as a “transparent, accessible and re-
sponsive governance system, where information moves freely both to and from
government, through a multitude of channels” (OECD, 2009: 8), according to
Evans and Campos open government “is widely understood as the leveraging
of information technologies to generate participatory, collaborative dialogue be-
tween policymakers and citizens” (Evans and Campos, 2013: 173). The basic
idea of the open government concept is to increase citizen trust into the gov-
ernment through transparency, participation, and collaboration (Janssen et al.,
2012; Lee and Kwak, 2012; Reddick and Ganapati, 2011, Wirtz and Birkmeyer,
2015, United Nations, 2014). What transparency, participation and collabora-
tion mean in the context of open government is summarized in Table 1.

Principe Related concepts

Transparency Information access
Accountability
Legitimacy and trust in government
Participation Consultation and deliberation with citizens
Participation in decision-making processes
Participation in public policy design
Collaboration Interoperability
Co-production
(Social) innovation
Table 1. Open government principles and related concepts (Gascó, 2013)

Open data and open action are two essential tools which government can use
to foster transparency, participation, and collaboration, e.g., to put into life main
open government principles. Open data refers to data available in standard-
ized, structured and machine-readable formats. Open action means the use of
web 2.0 tools and, particularly, of social media and blogging (Gascó-Hernández
and Fernández-Ple, 2014).
However, despite huge potential of social media in providing open government,
the governments generally lack to exploit them to the full capacity. The results
of research presented in this paper try to answer to question: what is the situ-
ation regarding use of social media as a tool for ensuring open government in
transition countries, in this case Western Balkans countries that were belonging
to one state in the past (Bosnia and Herzegovina, Kosovo, Montenegro, Serbia
and the former Yugoslav Republic of Macedonia).

355
The authors decided to analyze those countries because of a similar level of
economic development and reforms in government institutions. Although gov-
ernments of chosen countries accepted social media as a communication
channel, they used them mostly to publish promotional information about their
work, while two-way communication with citizens is still missing.

2. Literature review
Although most of the authors agree that social media have a huge potential in
addressing the open government challenge (Bonsón et al., 2012; Evans and
Campos, 2013; Lee and Kwak, 2012), the governments still struggle with imple-
mentation of social media. According to (Wirtz et al., 2017) the scientific litera-
ture related to the use of social media as a tool that fosters open government
can be divided into three groups (Table 2) regarding:
1. Implementation process and maturity
2. Social media deployment and use
3. Coproduction factors and benefits.

Authors (year) Research orientation

1. Dadashzadeh Social media usage at local, regional, and
Implementation (2010) national public authorities (governments) should
process and be the result of strategic planning at all levels.
maturity Mergel and They suggest that the implementation and use
Bretschneider of social media applications follows a three-step
(2013) process: from experimental and informal, via
informal standards, to formalized policies.
Lee and Kwak They provide a maturity model on social media
(2012) for open government. They propose a sequential
development of open government principles
with increasing social media-based public
engagement. These studies outline technological
and functional development stages and
implementation processes.
Criado and The use of social media by public administrations
Rojas (2012) is an expanding and multidisciplinary
phenomenon.
Landau (2011); Social media’s attributes (immediacy, ubiquity,
Lindsay (2011) and availability) make them very useful
in sharing, especially in times of crises or
emergency situations
Picazo-Vela et Public administrations use social media with
al. (2012) different purposes: to carry out recruiting tasks,
to reach citizens and other stakeholders, to share
information with other public organizations, to
promote citizen participation in public issues or to
improve transparency.

356
 Authors (year) Research orientation
2. Sandoval- Address the development of local government
Social media Almazan and portals in Mexico regarding collaboration and
deployment Gil-Garcia participation. They showed that only a fifth
and use (2012) includes tools for interaction and participation,
concluding that open government initiatives
should be supported by social media
Bonsón et al. Analyzed the use of Web 2.0 and social media
(2012) within local governments in the European Union.
They concluded that social media implementation
shows a heterogeneous picture and that full
potential of social media is not exploited.
Unsworth and Analyzed social media use by the United States
Townes (2012) Department of Agriculture. Their key outcomes
are that social media are not used in a way that
promotes open government.
Katz and Empirical studies are dealing with the adoption
Halpern, 2013; of social media in an open government context
Ma, 2013; of different countries. The studies show
Riarh and Roy, relatively low social media adoption rates and
(2014) unsatisfactory utilization of installed applications

Bryer (2011) Analyzes challenges of the deployment of social

media in the context of public participation. The
study emphasizes the importance of considering
multi-stakeholder relationships instead of
unidirectional or asynchronous communications
ways
3. Meijer’s (2011) The study highlights the role of virtual
Coproduction communities for networked coproduction in the
factors and public sector.
benefits Linders (2012) Focuses on the coproduction factor and
emphasizes the importance of citizen
coproduction in the delivery of public services in
the age of social media.
Chun and Cho Study the implementation and outcomes of a
(2012) social media participation platform that is used
for citizen participation in policy decision-making
in Korea.

Table 2. Short literature review according to Wirtz et al. (2017) Classification

This short literature review presented in Table 2 shows that the authors are
aware of the importance of social media for citizen collaboration and as a tool
that can foster transparency and participation. The authors recommend imple-
menting social media within open government initiatives, but they stressed the
necessity to better exploit advantages and disadvantages of social media (e.g.,
Bryer and Zavattaro, 2011; Chun and Cho, 2012; Linders, 2012).

357
Regarding research related to Western Balkans countries, the ReSPA (Region-
al School of Public Administration) together with its E-Government Network
members and respective regional and international experts, conducted two
comparative studies. The first one was conducted in 2013, and it was devoted
to e-government in the Western Balkan region. In 2015, the second one, follow
up study - “From E- to Open Government” was made.
The results of the last study showed that Bosnia and Herzegovina is performing
less well than the regional average on both e-government and open govern-
ment. Namely, BiH had relatively well results referring to transparency, but less
well on collaboration and poorly on participation. Regarding the former Yugo-
slav Republic of Macedonia (FYRM) is, similar to BiH, performing less well than
the regional average on e-government, but it had an exceptional performance
as a leader on transparency and a good performance on participation in the
context of open government. According to this study, Kosovo is the weakest of
the six participants in both e-government and open government. As opposed
to other WBC Kosovo started later and still has huge political and institutional
challenges. The study showed that Montenegro is a regional leader in both
e-government and open government. Montenegro is doing extremely well on
participation and very well on collaboration compared with the average, but re-
lated to transparency has only an average score. Regarding Serbia, the study
showed the average level of both e-government and open government. Serbia
has very well results related to transparency and participation, but it has lack of
any real efforts regarding collaboration (ReSPA, 2015).
The ReSPA studies showed that, in spite of all challenges, WBC try to catch up
with developed countries related to both e-government and open government.
In line with that efforts, the researchers from WBC have become more interest-
ed in analyzing the use of social media as a tool for fostering open government
in their countries (Mabić et al., 2017; Rexepi et al., 2016; Đurić-Atanasievski
and Bobar, 2016; Budinoski and Trajkovik, 2012).

2.1. Western Balkans countries and open government initiative

The literate review shows that the governments all over the world have become
aware of the requirements of their citizens for more transparent, collaborative
and participant government. This was the main driver in establishing the Open
Government Partnership (OGP) as a multilateral initiative that aims to secure
concrete commitments from governments to promote transparency, empower
citizens, fight corruption, and harness new technologies to strengthen govern-
ance. The Open Government Partnership formally started in 2011, when the
8 founding governments (Brazil, Indonesia, Mexico, Norway, the Philippines,
South Africa, the United Kingdom and the United States) endorsed the Open
Government Declaration, and announced their country action plans. Since
2011, OGP has welcomed the commitment of 67 additional governments to join
the Partnership (OGP, 2017).

358
In its current strategy, OGP defined that its “vision is that more governments be-
come more transparent, more accountable, and more responsive to their own
citizens, with the ultimate goal of improving the quality of governance, as well
as the quality of services that citizens receive” (OGP, 2016: 2).
The analysis of the first five OPG’s years showed that the national OGP pro-
cess has helped countries establish institutional mechanisms that give continu-
ity and legitimacy to open government reforms, made dialogue and co-creation
regular features of the interactions between OGP reformers, and initiated re-
forms that change the status quo and benefit citizens (OGP, 2016).
However, there are significant differences by OGP’s membership countries re-
lated to establishing necessary institutional mechanisms as prerequisites to
open government reforms and in achieving government’s transparency, part-
nership, and collaboration. In Table 3 is presented current status in OPG by
WBC, except Kosovo which is not a member of OGP.

Country Joined No. of No. of Action Plan Status in OPG

Commit- theme Thematic focus
ments covered (themes that
governments have
focused on in
their commitment
development)
Bosnia and 2014 0 0 Bosnia and The government of
Herzegovina Herzegovina did Bosnia and Herzegovina
not submit National has a new deadline
Action Plan of August 31, 2018,
to submit a two-year
national action plan
ending on June 30, 2020
Montenegro 2011 56 0 20% Conflicts of Inactive
interest (The Government of
18% Legislation Montenegro has not
and Regulation submitted its new NAP)
14% Private sector Montenegro has now
acted contrary to the
OGP process for three
consecutive action plan
cycles: 2014, 2015 and
2016
Serbia 2013 27 11 71% Legislation Second National Action
and Regulation Plan 2016-2018 is
57% Public posted
participation
50% Public service
delivery
The Former 2011 120 22 47% e-government National Action Plan
Yugoslav 32% Legislation 2016-2018
Republic of and Regulation
Macedonia 29% Subnational
Table 3. Open government partnership – WBC status
Source: https://www.opengovpartnership.org/participants [Accessed: March 21, 2018]
359
As it is visible from Table 3, there are substantial differences between WBC in
status in OGP. The situation is slightly different from the ReSPA research from
2015. Namely, in the ReSPA study, Montenegro was a leader in both e-govern-
ment and open government (ReSPA, 2015), but currently has inactive status
in OGP because it did not submit obligatory a two-years National Action Plan
on Implementation of the Open Government Partnership Initiative since 2014
and did not cover any of committed themes. As expected, BiH just signed a
partnership, without any defined nor covered committed themes. Also, BiH did
not submit a two-year National Action Plan on Implementation of the Open
Government Partnership Initiative till now.

3. Methodology/Method/Model/Conception of analysis
The empirical research included the government of Western Balkans countries
(WBC): Bosnia and Herzegovina, Kosovo, Montenegro, Serbia and the former
Yugoslav Republic of Macedonia. These states have belonged to one state in
the past and today have a similar level of economic development and reforms
in government institutions. Except for these countries, the analysis was carried
out for Croatia and Slovenia. These counties are already members of European
Union, but share the same past with WBC (former Yugoslavia). It is interesting
to compare them with WBC in order to see if there are any differences, e.g. if EU
membership influenced their progress in the use of social media in government.
Table 4 shows a list of countries included in research and their governments’
web addresses.

Country Official website of the Government

Bosnia and Herzegovina http://vijeceministara.gov.ba/Default.aspx?langTag=hr-
HR&template_id=91&pageIndex=1
Kosovo https://www.rks-gov.net/sr-latn-cs/pages/fillimi.aspx
Montenegro http://www.gov.me/naslovna?alphabet=lat
Serbia http://www.srbija.gov.rs/
The former Yugoslav http://www.vlada.mk/
Republic of Macedonia
Croatia https://vlada.gov.hr/
Slovenia http://www.vlada.si/

Table 4. List of countries included in research

Source: Authors’ preparation

The content analysis of their governments’ websites was conducted, together

with an analysis of links to social media platforms.
Activities of WBC on social network sites were analyzed through two aspects.
It was investigated whether the links to social network sites were available on

360
official WBC’s websites and whether these links were valid and active. If the
links were not found on the home page, it was checked whether they were avail-
able on the contact page. Availability of the WBC’s web pages on social network
sites was also checked directly by searching on the social networks sites.
Basic characteristics of official profiles of the governments (numerical indica-
tors available on the social network sites and published content) were analyzed
on the most common social networks sites. The analysis was conducted during
March 2018.
The descriptive statistical analysis was performed about the adoption and use of
each social media application by the government of Western Balkans countries.
This paper presents the empirical research related to the Western Balkans
countries’ social media adoption and use. The main research questions are
how social networks were adopted and used by Western Balkans countries,
and are they active or passive users? Also, the results of research can be used
for analyzing these countries related to the context of open government, and for
the evaluation of previously taken activities on transparency and collaboration
with citizens.

4. Empirical data (documentation background) and analysis

Table 5 shows social network sites where the analyzed countries have official
pages. Data related to Kosovo did not found, so Kosovo is excluded from this
analysis.

Used Social Network Sites

Countries
(link available on official websites)
Bosnia and Herzegovina Twitter, YouTube, Facebook*
Montenegro Twitter, Google+, Facebook*
Serbia Twitter
Macedonia Facebook, Twitter, Flickr, YouTube, Instagram
Croatia Facebook, Twitter, Flickr, YouTube, Instagram, LinkedIn
Slovenia Facebook, Twitter, Flickr, YouTube, Instagram, LinkedIn

Table 5. Use of SNS across governments

Note: *the profile founded by additional search (Google or SNS search)
Source: Authors’ preparation

It should be stressed that the search on Facebook for specific countries offers
profiles that look as official, but neither one has a note that confirms that it is
an official profile. Also, some of the profiles in their description have statements
that resemble official government portal (description of one of the founded pro-
files of the Government of the Republic of Serbia on Facebook is Education
Website). Official profiles of the countries included in the research are on local

361
 language, except the Government of Republic of Slovenia which has two offi-
cial profiles, one on the Slovenian and other on the English language.
The analysis of the link accessibility to SNS on official websites of researched
countries gave some interesting results. Namely, on the websites of Montene-
gro and Serbia governments exists the option of e-Government. Website of
Montenegro government has a link to Open Government Partnership site. RSS
(Really Simple Syndication) – as an option which logged users notify about
new posts was founded at the official websites of the Kosovo, Montenegro and
Serbia governments. At the website of the Council of Ministries of Bosnia and
Herzegovina exists logo for e-Government, but clicking on it nothing happened.
At the same website on the menu exists option eGovernment which offers two
possibilities: the sitemap and the sessions, but under sessions, there is no any
information.
Regarding the fact that it was founded that most of the researched countries
have an official profile on Twitter and Facebook, detailed analysis of the official
profiles on SNS was conducted only on Twitter and Facebook.
Table 6 shows numerical data of official SNS profiles.

BiH Montenegro Serbia Macedonia Croatia Slovenia

TWITTER
Tweets 783 3947 2711 10.7 K 58.5 K 16.4 K
Following 349 291 120 177 19.3 K 10.2 K
Followers 807 8293 12.5 K 6840 168 K 63 K
Likes 2 1526 207 269 5553 303
Last activity 29.3.2018 1.4.2018 28.3.2018. 2.4.2018 2.4.2018 30.3.2018
Joined April December June September December June
2016 2011 2012 2011 2011 2009
Photos/ videos 360 1867 830 6666 1477
Lists 1 1 15
FACEBOOK
Like 60 11249 24381 156115 3247
Follow 60 11417 24508 152827 3351
Last activity 1.4.2018 2.4.2018 29.3.2018 1.4.2018
Joined

Table 6. Numerical characteristics of official profiles on SNS

Note: Analysis completed on 02/04/2018;
Source: Authors’ preparation

362
Table 7 shows numerical analysis of the last 30 tweets for analyzed countries.

Period (Days) Tweet /reTweet Reply /Retweet /Like

(% reT) Total Average
Bosnia and 16.3.-29.3 (14) 22/8 (26.7 %) 2 /44 /160 0.07 /1.47 /5.3
Herzegovina
Montenegro 23.3.-1.4. (10) 27/3 (10 %) 7 /44 /239 0.2 /1.5 /8
Serbia 26.1.-28.3. (62) 29/1 (3.3 %) 18 /220 /395 0.6 /7.3 /13.17
Macedonia 28.3.-2.4. (6) 23/7 (23.3 %) 18 /81 /207 0.6 /2.7 /6.9
Croatia 30.3.-2.4. (4) 28/2 (6.7 %) 66 /53 /169 2.2 /1.8 /5.6
Slovenia 29.3.-1.4. (4) 4/26 (86.7 %) 36 /136 /292 1.2 /4.5 /9.7

Table 7. Numerical analysis of the last 30 tweets

Source: Authors’ preparation

5. Results and discussion

The results of the conducted research show that WBC have a significant lag
in using SNS compared to neighboring countries, Croatia and Slovenia, which
are members of EU. Croatia and Slovenia have official profiles on six SNS,
while most of WBC have one to two SNS, except Macedonia, which has pro-
files on five SNS. Regarding the links to SNS on official websites, BIH has two
links, Montenegro and Serbia have one, Macedonia has five, while Kosovo has
no links to SNS. Additional search on Google and specific SNS showed that
Montenegro and BiH have official profiles on Facebook although they are not
specified in the official websites of these countries.
According to the dates of last posts and the analysis of the time for the last 30
tweets on Twitter, it can be concluded that researched governments relatively
actively use their Twitter profiles. The only exception is Serbia because it was
realized its 30 Tweets in considerably longer time compared to other countries
(Serbia through two months, while other countries through two weeks). The
activities on other SNS are not indicative. The posts are especially rare on
YouTube and Google+.
The analysis of the activity and attractiveness of analyzed governments on
SNS, based on numerical data available on official SNS profiles, shows that
Bosnia and Herzegovina has considerable lag compared to other countries.
This lag refers to the number of followers, number of following, number of likes
and shares, except for the number of posts. The reason for this lag can lay in
the fact that the Council of Misters of BiH has presented on Twitter just since
the April 2016, while the governments of other countries have been on Twitter
more than five years. But, on the other hand, if the frequency of post and the

363
reactions of the followers, e.g., citizens on the governments’ posts, is analyzed,
then there is no significant difference between BiH and other countries. Howev-
er, the Twitter analysis showed that WBC have lag related to a number of their
followers’ comments compared to Croatia and Slovenia.
Once again, it should be emphasized that Serbia realized its 30 tweets through
considerably longer time than other WBC, although the number of comments to
tweets of Serbia is relatively similar to the results of other WBC. The analysis of
the official Twitter profiles showed that some countries have a specific number
of retweets, e.g., sharing of somebody else’s tweets (Slovenia leads in that).
The share of retweets in WBC regarding last 30 Tweets is up to 30% that shows
that the own tweets are prevailing (BiH and FYRM are near the upper limit,
while Montenegro and Serbia have considerably less number of retweets).
About the fact that the governments of countries were analyzed, as expected,
the content analysis of SNS’s profiles showed a high diversity of posts. Name-
ly, the governments have different portfolios, duties, and responsibilities, so it
makes sense that the posts are uneven.
Published content mostly includes messages with announcements or sched-
ules about activities to be held by the government or some their institutions
or public agencies. Above all, there is the information about the meetings of
governments’ officials with officials from foreign countries, as well as the infor-
mation about participation at different events. All that information belonged to
the promotion. It is clear that citizens should be informed of these activities, but
for them are more important the information about the concrete activities that
governments take and which influence their quality of work and life in the spe-
cific country. The analysis showed that such information are not usual on SNS
profiles. It should be stressed that on the Twitter profile of BiH government one
can find agendas for some sessions of the Council of Ministries of BiH, while
that is not the case with other WBC.

6. Conclusions
The results of the conducted research show that WBS are present on SNS. Ac-
cording to the numeric indicators (number of followers, the frequency of posts/
tweets), the situation is relatively good, and with some exceptions (retweets) it
is not dramatically different compared to the situation in EU members - Croatia
and Slovenia.
But, the conclusion regarding activities of WBC governments on SNS cannot
be based only on the number and frequency of posts/Tweets, retweets, follow-
ers. In spite of some positive results (number of posts/tweets), WBC lack of
collaboration and participation of their citizens which is contrary to open gov-
ernment initiative. Namely, although maybe older population is not familiar with
SNS, for the younger population the SNS is part of their everyday life and usual
way of communication. Unfortunately, WBC governments are still not aware

364
that social media, especially SNS should be used as a communication channel
with their citizens that provide them with the opportunity to be more included in
the decision-making that influences the way how they work and live.
It is necessary to say that frequency of posts/tweets can be one of the reasons
for the passivity of the followers. Although there is an opinion that the frequent
posting of content on SNS, with the aim to inform public with the activities of
governments, foster transparency, the truth is that too many unplanned posts
can generate surfeit by information and citizens’ SNS passivity. Inevitably, the
question is, are governments posting on SNS the contents that are important
to their citizens or themselves? Also, the question is have the governments de-
veloped a strategy for the presentation on SNS, especially related to frequency,
timing and content of the posts in order to influence SNS activity of citizens.
Considering these questions in the context of conducted research, the answer
intrudes that some WBC started their SNS story following the general principle
“everybody is present on SNS, so we also should be there.” But, the analysis
of the WBC status in OGP (Table 3) shows that there are significant differences
related to establishing necessary institutional mechanisms as prerequisites to
open government reforms and in achieving government’s transparency, part-
nership and collaboration (FYRM and Serbia are leaders, Montenegro lags,
BiH is at the beginning, while Kosovo is not member of OGP).
On the one hand, transparency means that data and information related to the
activities of government should be presented to citizens, but it is not enough.
In order to achieve open governance, the government should find a balance
between transparency, participation, and collaboration. Unfortunately, that is
not the case with WBC because participation and collaboration are still huge
challenges for their governments. The publishing of just promotion activities
and the announcement of events makes an impression on citizens that all SNS
activities are in service of government’s officials promotion and for the sake of
keeping their positions and benefits.
SNS is just one of the different social media that can support governments in
the implementation of open government initiative. Since Millennium genera-
tions have accepted SNS as a natural way of communication and collaboration,
the governments should understand that SNS can be a powerful tool in foster-
ing open government initiative if they are used adequately. As OPG proposed,
WBC should adopt strategic approach related to the implementation of SNS
in order to establish institutional mechanisms that will provide continuity and
legitimacy to open government reforms.

365
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 CHAPTER 22

Happy organization - myth or reality

for Croatian organizations

Ivana Maric1, Maja Vidovic2

ABSTRACT

Human resource management, a well-established discipline, is constantly searching for

new ways to provide a leading edge to companies. A connected concept of employ-
ee engagement, a hot topic amongst managers, consultancies, governments and aca-
demics alike, is likewise considered crucial for successful management of a productive
workforce in organizations (Farndale and Vidovic, 2017). The employee engagement,
which can be considered as the holy grail of human resource management activities,
has also been providing new insights into building a successful global company. En-
gaged employees are said to be optimistic, highly focused on their work, enthusiastic
and willing to go the extra mile to contribute to sustainable organizational success on a
long-term basis (Jose and Mampilly, 2012). It is exactly the aspect of optimism, positivity
and happiness, that this paper will seek to further explore and build up on, in order to
provide a new boost for contemporary global competitiveness. As a part of the research,
the authors organized a survey to collect further insight into the perceptions of Milleni-
als that are preparing to enter the workforce. The survey targeted 167 sophomore and
junior college students from business schools, collecting information on their perception
of happiness, and the expectations they have of achieving happiness in the workplace.
The survey also collected data regarding the importance of various factors influencing
their perception of the happy organization, and the possibility of building one. Based on
the research data, the paper provides valuable feedback on the most important aspects
the companies should focus on in order to provide their employees with a happiness-en-
abling working conditions. By doing so, the paper aims to effectively describe a blueprint
for building sustainable happy organizations.

Key words: happy organization, happiness, employee engagement,

human resource management

JEL classification: M12, M14, M59

1 Assistant Professor, University of Zagreb, Faculty of Economics and Business, Trg J. F. Kenne-
dya 6, 10 000 Zagreb, Croatia. Phone: +385 1 238 3235, E-mail: imaric8@net.efzg.hr.
2 Lecturer, Rochester Institute of Technology Croatia, Zlatka Tomljanovića Gavrana 15, 10 000
Zagreb, Croatia. Phone: +385 1 643 9100, E-mail: maja.vidovic@croatia.rit.edu.

371
1. Introduction
Companies that belong to the contemporary complex, ever-changing and net-
worked society are constantly on the lookout for new ways of conducting busi-
ness ever more successfully. The society that values sustainability, self-organ-
ization, development and learning is pushing for companies to become more
creative, innovative and global.
People, their experience, talents and competencies, have long been consid-
ered a key source of sustainable competitive advantage (Frank and Taylor
2004; Lewis and Heckman 2006, Berisha Qehaja and Kutllovci 2015, Maric,
2015). It is exactly the employees that make a difference between a successful
and non-successful company. Based on this premise, many of the disciplines
revolving around managing employees are nowadays searching for new and
innovative ways to capture the essence that distinguishes fast-growing, desir-
able companies.
Human resource management, a well-established discipline, is constantly
searching for new ways to provide a leading edge to companies. A connected
concept of employee engagement, a hot topic amongst managers, consultan-
cies, governments and academics alike, is likewise considered crucial for suc-
cessful management of a productive workforce in organizations (Farndale and
Vidovic, 2017). The employee engagement, which can be considered as the
holy grail of human resource management activities, has also been providing
new insights into building a successful global company. Engaged employees
are said to be optimistic, highly focused on their work, enthusiastic and willing
to go the extra mile to contribute to sustainable organizational success on a
long-term basis (Jose and Mampilly, 2012). It is exactly the aspect of optimism,
positivity and happiness, that this paper further explores and build up on, in
order to provide a new boost for contemporary global competitiveness.

2. Building employee well-being as a base for happy

organizations
The meaning of well-being in the context of business is not easy to define, it is
a quite complex and multidimensional term because it questions the meaning
of organizational and individual happiness. Well-being, could be described as a
positive approach to life and health, that involves the whole person – physical-
ly, emotionally and on the psychological level (Schultz & van der Walt, 2015).
Harrison (2016) summarizes the diverse offer of well-being definitions. He ar-
gues that for some, the expression refers to an individual’s mental health; for
others, an individual’s overall health – mental, physical and emotional. Further,
he points that for some, well-being refers to a work initiative or programme
focused on bolstering education and understanding of what it takes to stay
well, while for others it’s a central tenet of an organization’s purpose, to create
positive outcomes for all employees; balancing this need against the demands
of shareholders or owners, taxpayers or customers.

372
Researching well-being in organizations is gaining more popularity in the recent
years, because management, and human resource managers especially, are
aware that employee well-being is connected with high performance, and must
be pursued at the individual, organizational and societal level.
The pursuit of happiness is a concept not only known in business, but even
more in private lives of all humans. To be happy is certainly one of the basic
human desires. The earliest researcher to recognize the importance of indi-
vidual happiness for the businesses was Abraham Maslow, describing it in his
famous „hierarchy of needs“. His theory sets the foundations for understanding
human motivation, by outlining several levels of aspirations that humans seek
to accomplish. The base of the pyramid make the physiological needs for air,
food and water, followed up with a need for safety, and a need for love and
belonging. The higher level of pyramid is made of needs that are presumed to
become evident only after these basic survival needs are being met. The top
motivational needs are the need for esteem, both self-esteem and respect,
recognition and status, and self-actualization. Maslow insists that the urge for
self-actualization is deeply entrenched in the human psyche, but only surfaces
once the more basic needs are fulfilled (Setton, 2018).
Some of the factors that are known to contribute to individual happiness are
the feelings of freedom, choice, creativeness, dignity, well-balanced relation-
ships with the people around them, achieving a good work-life balance, having
a decent salary and recognition for their work. Employees further seek that their
jobs should be challenging, interesting and creative, allowing for their individu-
al potentials to shine. Arguably, majority of these factors are closely related to
the business environment, making the pursuit of happines highly-dependent on
business decisions and business practices. In simple words, well-being is a per-
sonal state that ebbs and flows throughout the working day (Bailey, 2016, 36).
Ricard (2008) points out that passionate search for happiness is a goal that de-
serves at least as much energy as any other in our lives. Wealth? Fitness? Ca-
reer success? How can we possibly place these above true and lasting well-be-
ing? A personal well-being lifestyle is associated with good physical health,
emotional stability, improved personal relationships and increased career sat-
isfaction (Schultz & van der Walt, 2015). Further, employee happiness is asso-
ciated with a variety of positive outcomes, such as creativity (Lyubomirsky et
al., 2005, Csikszentmihalyi, 1997), better physical health (Veenhoven, 2008).
On the other hand, unhappy employees are fond the be less innovative (Dolan
& Metcalfe, 2012) and more prone to take sick days off (Soane et al., 2013).
In his book Happiness By Design, Dolan (2014), argues that happiness should
be defined as the flow of pleasure and purpose over time. Therefore, he ar-
gues, a happy life is one in which an individual has daily experiences that gen-
erate a good balance between fun on the one hand and fulfillment on the other.
Experiential evidence suggests that people who experience more purpose at
work are not only happier, but also more productive (Steger et al., 2012).

373
Well-being is now seen to be a fundamental aspect of an organization’s human
capital: the knowledge, skills and experience of employees (Roslender et al
2009). Creating the conditions that promote healthy and productive working
environments is now part of most HR professionals’ roles, and it is this manage-
ment of employee well-being which has become a central activity for high-per-
forming organizations (British Psychological Society 2010). In other words, pur-
suing employee well-being needs to be a combination of people-focused HRM
policies and practices, adequate fit between employees and the organization
and continuous focus on achieving and sustaining well-being (Figure 1).

Figure 1. Well-being in an organization

3. Building a healthy workplace

An increasing number of organizations, small and large, local and global, now
recognize that they are only as strong as their people. They depend on having
a healthy and productive workforce and they know that when employees feel
their work is meaningful and they are valued and supported, they tend to have
higher well-being levels, be more committed to the organization’s goals and
perform better (Farmer, 2016).
So how exactly do companies build a healthy workplace, that promotes em-
ployee well-being? Dodge and colleagues (2012, 230) claim: „stable well-being
is when individuals have the psychological, social and physical resources they
need to meet a particular psychological, social and/or physical challenge“. Also,
there is good evidence that positive features of the employment relationship are
associated with higher well-being (Guest, 2016, 6-7). Donald-Feilder and Lewis
(2006) researched healthy organizations and found that creating a healthy or-
ganizational context is vital to developing and supporting good leadership and
management.
The literature is clear on the key domains that influence well-being in the work-
place, as well as the suggestions of the most effective people-oriented practic-
es to support sustainable well-being, as outlined in Table 1.

374
 Domain Elements Examples of well-being initiatives/activities
Health promotion, good rehabilitation practices, health checks, well-being benefits, health insurance
Physical health
protection, managing disability, occupational health support, employee assistance programme.
Physical safety Safe working practices, safe equipment, personal safety training.
HEALTH
Stress management, risk assessments, conflict resolution training, training line managers to have
Mental health difficult conversations, managing mental ill-health, occupational health support, employee assistance
programme
Working environment Ergonomically designed working areas, open and inclusive culture.
Good line management Effective people management policies, training for line managers, sickness absence management.
Work demands Job design, job roles, job quality, workload, working hours, job satisfaction, work–life balance.
WORK
Autonomy Control, innovation, whistleblowing.
Change management Communication, involvement, leadership.
Pay and reward Fair and transparent remuneration practices, non-financial recognition.
375

Values-based leadership, clear mission and objectives, health and well-being strategy, corporate
Leadership
VALUES/ governance, building trust.
PRINCIPLES Ethical standards Dignity at work, corporate social responsibility, community investment, volunteering.
Diversity Diversity and inclusion, valuing difference, cultural engagement, training for employees and managers.
COLLECTIVE/ Employee voice Communication, consultation, genuine dialogue, involvement in decision-making.
SOCIAL Positive relationships Management style, teamworking, healthy relationships with peers and managers, dignity and respect.
Mentoring, coaching, performance management, performance development plans, skills utilisation,
Career development
succession planning.
PERSONAL Emotional Positive relationships, personal resilience training, financial well-being.
GROWTH Performance development plans, access to training, mid-career review, technical and vocational
Lifelong learning
learning, challenging work.
Creativity Open and collaborative culture, innovation workshops.

Table 1. Five domains of well-being

Source: Miller and Suff (2016: 18)
Building upon all these findings we can construct the model of a healthy work-
place, that includes the elements as shown on Figure 2.

Figure 2. Five dimensions of a healthy workplace in the context of promoting well-being

4. Research methods and results

As a part of the empirical research for this paper, authors aimed to capture
the perceptions of Millenials, that are preparing to enter the workforce, on the
topic of well-being and a happy organization. The specific Millenials’ cohort that
was chosen for this study is the cohort of young future professionals, currently
pursuing higher education, and with a fairly limited exposure to the real busi-
ness world. Targeted participants were sophomore and junior college students,
specifically from business schools, as the ones perhaps the most focused on
joining the business world of tomorrow.
In order to collect the most thorough data, the authors applied two-tier research
approach. In the first step, a qualitative research analysis was applied, followed
by a second step with a quantitative research method. The qualitative research
consisted of conducting a focus group interview with a selected group of stu-
dents from a business school at a public university. Through that focus group,
initial data was gathered to help explain the initial viewpoints that Millenials
have on the topic. Quantitative research collected information on Millenials’
perception of happiness, and the expectations they have of achieving happi-
ness in the workplace. The survey also collected data regarding the importance
of various factors influencing their perception of the happy organization, and
the possibility of building one.
The qualitative part of the study was focused on searching for the right asso-
ciation for a term „happy organization“. Millenials found different meanings for
the term – form happiness, creativity to high-quality interpersonal relationships.
The most common terms found to be most closely related to the concept of a

376
happy organization included: happiness, creativity, passion to work, high pay,
stimulation, flexible working hours, team building, sport, healthy snacks, free
time, social atmosphere, high-quality interpersonal relationships.
Following up on the initial results, that proved Millenials view happiness as
being closely connected to both personal and work-related roles and goals, the
authors designed a research questionnaire. The questionnaire was adminis-
tered to students in a pen-paper form, collecting their further responses on the
topic. The questionnaire was filled by 167 Millenials, with the following charac-
teristics (Table 2).

Characteristic Results
Gender Male (37,72%), female (62,28%)
Type of college Private (53,89%), public (46,11%)
Work experience Not at all (15,04%), up to 3 months total (21,56%), up to 6
months total (20,96%), up to one year total (14,30%), more than
one year in total (28,14%)

Table 2. Characteristics of the reserch participants

Using a Likert-type scale of 1 to 5 to describe the degree in which they agree

with a statement (from 1= completely disagree, up to 5 = completely agree), the
Millenials provided the following insights (Table 3).

Statement Average St. Dev.

On average, employees are happy in their workplaces 2,85 0,63
It is important that an employee is happy in the workplace 4,84 0,78
It is important to me personally that I am happy in the workplace 4,88 0,65

Table 3. The degree of agreeing with the proposed statements

Based on the results from the previous table, it is evident that Millenials find it
highly important that they are happy in the workplace. Interestingly, on average,
Millenials find that other people are slightly less concerned with being happy
in the workplace, which perhaps indicates an understanding that the young-
er generations might be more interested in organizational happiness than the
more experienced ones. On the other hand, an increasingly worrying observa-
tion the Millenials are making, is that on average, employees are not happy in
Croatian workplaces. The mismatch between the importance of a concept, and
the reality in the workplace, clearly calls for action.
Further topic researched through the quantitative study was the importance of
four key factors for the happiness in the workplace. The key factors that were
researched were: (1) the salary, as measured through regularity of salary pay-
ments, the level of salary and the possibility of salary growth through time; (2)
interpersonal relationships in the workplace, as measured through communi-
cation quality with the closest associates, with direct superiors, trust amongst

377
employees in the workplace and the level of respect that employees receive
in the workplace; (3) the type of job an employee is performing, as measured
through clear purpose, influencing organizational performance, participation in
the decision-making process, perceiving a job as play and enjoyment, challeng-
ing tasks as part of the job, independence in creating and performing the job,
the possibility of learning and development and the possibility of climbing the
corporate ladder; and (4) aligned personal and organizational values, as meas-
ured through perception of the product/service as important and valuable, and
trusting the decisions made by the managers. The questionnaire was capturing
the level of agreement with the statements, again using the Likert-type scale of
1= not important at all to 5= extremely important. The results for the average
importance are shown in Table 4.

Factor Average St. Dev.

The salary 4,56 0,41
Interpersonal relationships in the workplace 4,50 0,51
The type of job an employee is performing 4,21 0,47
Aligned personal and organizational values 4,09 0,62

Table 4. Importance of different factors influencing happiness in the workplace

Aligned with the general perception of Millenials as being highly materialistic

and focused on the salary (Poloski Vokic & Vidovic, 2017), the research results
show the vast influence the salary is having on the happiness in the workplace,
as perceived by the Millenials. In their opinion, it is the salary that is the domi-
nant drive of happiness in the workplace, slightly overshining the interpersonal
relationships in the workplace, which are still found to be significantly impor-
tant. On the other hand, the type of job an employee is performing, although
important, could not be defined as extremely important to Millenials. Probably
again reflecting their inherent materialistic desires. Again, drawing on Maslow’s
hierarchy of needs as described earlier in the paper, it could be that the young
soon-to-be-professionals are currently focused on meeting the basic needs of
food and shelter, and are hence perceiving the salary as the means to achieve
this. It could be expected that young professionals that fall in the Millenial co-
hort, but already have more substantial work experience, are starting to change
their preference towards salary as opposed to other workplace characteristics.
One of the characteristics that became apparent from this survey is the fact
that Millenials tended to put a higher emphasis on the regular salary pay-
ments (avg=4,77; SD=0,49), than the opportunity for salary growth with time
(avg=4,54; SD=0,65). And both of these characteristics were apparently more
important than the actual level of salary (avg=4,37; SD=0,58). These results
further prove the assumption that the young Millenials are looking to have a
sustainable source of income to cover the basic life requirements.

378
Finally, the respondents were asked about the responsibility to build the happy
workplace and the happy organization. Being able to choose between should
the responsibility lie in the hands of the individuals, organizations or the society
in general (defined as political, legal, economic and cultural factors), these are
the respondents’ preferences (Table 5).

Stakeholder Average St. Dev.

The individual 4,16 0,84
The organization 4,27 0,76
The society 4,02 0,89
Table 5. Responsibility of different stakeholders for building happiness in the workplace

Judging from the data available, the Millenials seem to agree that the most
responsible stakeholder for building a happy workplace should be the organi-
zation. The individual itself is only in the second place, followed by the society
in general. To put it in other words, Millenials seem to agree that it is exactly the
HR policies and practices that the organization is fostering, that are building or
breaking the happiness in the organization.

5. Discussion
Taking into consideration the theoretical and empirical research and results, it
is obvious that there is a lot of room for people-focused practices that should
be targeting the goal of building a happy organization. The future young profes-
sionals and young executives seem to put a lot of emphasis on the importance
of a happy organization, seemingly expecting that the organization should be
the one taking care of the process.
In reviewing the most important actions that the organizations can make in or-
der to foster a happy workplace, it seems that the opportunity to satisfy the most
basic human needs, the needs for food, and a place to live, is the top priority.
Followed by providing meaningful interpersonal relationships in the workplace,
Millenials are again proving the value of Maslow’s hierarchy of needs. Both
the motivational theory and the research results show that after satisfying the
basic human needs, the need for social acceptance and forming interpersonal
relationships appear. According to Maslow’s theory, the desire for self-actual-
ization, as the final step in the hierarchy, can only be achieved after realizing
the lower-level needs. Similar to the concept of happy organization, seems
that the employee productivity and employee engagement, stemming from a
happy organization, can only be achieved as the crown of satisfying lower-level
human needs.

379
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381
 CHAPTER 23

Financial position and sustainability of

associations in Croatia

Davor Vašiček1, Ana Marija Sikirić2, Martina Dragija Kostić3

ABSTRACT

Multitude and heterogeneity of associations represent the fundamental infrastructure

of civil society and they are dominant part of the non-governmental non-profit sector.
Development, performance and significance of the non-profit sector are primarily de-
fined by non-financial and qualitative indicators of impact on narrow interest groups and
their contribution to the development of society as a whole. The development of the
non-profit sector is also considered to be one of the important indicators of the degree
of development of a country’s democracy. Although volunteering is largely voluntary,
the viability of citizen associations and other non-profit organizations is conditioned by
the availability of adequate economic and financial resources. Funding sources of NGO
vary and according to their non-market and non-profit orientation they are to a lesser
extent generated on the market in the sphere of social entrepreneurship.
This paper presents the research results of the funding sources, economic financial
potential and the elements of economic performance of citizens’ associations in the Re-
public of Croatia. The survey sample includes over 20,000 associations of citizens and
their associations which have delivered financial reports to the Registry of Non-profit
Organizations in accordance with the statutory obligation.
The research is based on aggregated data reported in the Balance Sheet and Perfor-
mance Report for years 2015 and 2016 and competent institutions reports on public
funding of associations’ general activities.
The results of the research provide valuable information and complete the picture of
the impact and economic importance of this segment of civil society in the national so-
cio-economic context.

Key words: associations, financial position, funding sources, performance

JEL classification: G34, M14, M41

1 Professor, University of Rijeka, Faculty of Economics and Business, Ivana Filipovića 4, 51000
Rijeka, Croatia. Phone: +385 51 355 154. E-mail: davor.vasicek@efri.hr
2 Postdoctoral Researcher, University of Rijeka, Faculty of Economics and Business, Ivana Fili-
povića 4, 51000 Rijeka, Croatia. Phone: +385 51 355 120. E-mail: ana.marija.sikiric@efri.hr
3 Assistant Professor, University of Zagreb, Faculty of Economics and Business, Trg John F.Ken-
nedy 6, 10000 Zagreb. Phone: +385 1 238 3156. E-mail: mdragija@efzg.hr

383
1. Introduction
Development, performance and importance of civil society organizations in wid-
er society is usually measured and evaluated using non-financial, qualitative
criteria of their impact on narrow interest groups and their contributions to the
development of society as a whole. While economic and financial component
of civil society organizations and non-profit sector is neglected not only in pro-
fessional analyzes and scientific research, but also for the purposes of macro-
economic management at the national level.
Activities of non-profit sector attract public and regulator’s attention only spo-
radically in the context of major political campaigns, large-scale humanitarian
actions or financial affairs involving prominent public figures. There is system-
atic neglect of the fact that a significant volume of civil society organizations
activities are funded from public sources and that there is high possibility of the
exploitation of their economic and financial unattractiveness and their relatively
privileged tax position. For these reasons, the main aim of this paper is, as a
result of the research, to present some of the key indicators of financial position
and financial performance of associations as the most important group of civil
society organizations and non-governmental non-profit sector in the Republic
of Croatia. For overview of the sample quality, scope of non profit sector, and in
particular the formal-legal framework and territorial distribution of its most sig-
nificant segment - citizens’ associations and their alliances, will be presented
in the paper. Special focus in the research will be put on funding associations
activities from public sources.

2. The scope of non-profit sector in Republic of Croatia

The characteristics of a non-profit organization do not necessarily depend on its
legal form, i.e. the activities and the purposes of the organization are more im-
portant than the character of its legal identity. Non-profit organization is defined
as a legal entity whose purpose and objectives of establishment and functioning
are not directed towards profit generation, but towards satisfying general inter-
ests and common needs of the wider community (Vašiček and Vašiček, 2016).
Governmental non-profit organizations also meet this definition, but since as
budget users they are merely funded from budget they are part of the public
sector, not non-profit sector4. According to international statistical classifica-
tion5 non-profit sector includes only nongovernmental nonprofit organizations

4 See more: Croatian Bureau of Statics: Sektorska klasifikacija institucionalnih jedinica, (S.13),
http://www.dzs.hr/app/sektorizacija/Documentation/SektorskaKlasifikacija.pdf and The Rule-
book on Determining Budget and Extra-budgetary Users of the State Budget and Budget and
Extra-budgetary Users of the Budget of Local and Regional Self-Government Units and on the
Method of Keeping the Register of Budgetary and Extra-budgetary Users, Official Gazette 128/09,
142/14
5 European Commision, EUROSTAT, European system of accounts - ESA 2010, Classification of
the purposes of non-profit institutions serving households (COPNI), http://ec.europa.eu/eurostat/
web/products-manuals-and-guidelines/-/KS-02-13-269, Str.545

384
founded on a private initiative that are dominantly financed through donations,
grants, membership contributions and other similar specific forms of financing
that are, as a rule, based on voluntary and humane grounds (European Com-
mission, 2010). So, non-profit sector in Croatia includes (Croatian Bureau of
Statistics, ny):
1. Trade unions, professional or school associations, consumer associa-
tions, political parties, churches or religious associations (including those
financed but not controlled by the state), and social, cultural, recreational
and sports clubs;
2. Charitable organizations, aid providing organizations that are financed
through voluntary transfers in cash or noncash transfers from other in-
stitutional units.
However, according to the Act on Financial Operations and Accounting of
Non-Profit Organizations (Official Gazette 121/2014), the non-profit sector
of the Republic of Croatia, with the exception of civil society organizations
(non-governmental domestic and foreign associations and their alliances,
trusts, foundations, art associations, trade unions, employer associations) also
includes all other legal entities that are non-profit by nature, although they are
founded and financed under special regulations (institutions, chambers, ...).
Except for the proclaimed non-profit character, the common denominator of
these entities is a unified system of accounting and financial reporting through
the Register of Non-profit Organizations (RNOs) managed by the Ministry of
Finance in common.
Because of the heterogeneity and the broad scope of the non-profit sector in
Republic of Croatia, the focus of the analysis is on the economic and financial
potential of associations and their alliances, which according to current data
from the RNO make up 33,191 organizations out of 35,780 non-profit organi-
zations or more than 92% of the non-profit sector of the Republic of Croatia6.

3. Citizens’ associations in the Republic of Croatia

Associations are the most common form of organized voluntary organization
of civil society that allow individuals to step out of their private sphere of family
and/or professional life without leaving them and influence on how common and
public functions are fulfilled. Law on Association (Official Gazette 74/17, 70/17),
which regulate the establishment, registration, legal status and termination of
existence of associations, as well as the registration and termination of activities
of foreign associations in the Republic of Croatia, define association represents
any form of a free and voluntary association of several natural or legal persons,
who shall, in order to protect their benefits or stand ups for the protection of hu-
man rights and freedoms, as well as the ecological, humanitarian, information,
cultural, ethnic, pro-natality, educational, social, professional, sports, technical,
6 Only organizations that have fulfilled their legal obligation to register in the Register are included.

385
health, scientific or other believes and goals that are not in contravention of the
Constitution, without an intention of gaining profit, comply with the rules that
regulate the organization and activities of such a form of association.
The Association as a non-profit organization does not perform its activity for the
purpose of gaining profit for its members or third parties. However, the non-profit
character of the association does not mean that the association can not engage
in social entrepreneurship, i.e. associations can perform revenue-generating
activities (in the market), but the revenue generated must exclusively be used
for the performance and improvement of the activities of the association that
enable achieving goals set by the statute. In that way, a non-profit organization
is not limited to earning income by performing “profitable” activities.
Legislative regulation on the “profit” activity of a non-profit organization is
based on assumption that these activities make relatively small part of over-
all economic activity which, in spite of the tax-privileged position of non-profit
organizations, does not disturb market competition, and that income earned in
those activities is intended to be consumed in accordance with the activity of
non-profit organizations, and not for making profit. Nevertheless, in spite of the
public benefit of its activity, the association becomes a taxpayer when it con-
tinuously performs more significant scope of market activities with the aim of
gaining economic benefits, thus seeking to eliminate its relatively privileged tax
position in compare to other economic entities7.
The association acquires its legal personality by registration in the Register of
Associations of the Republic of Croatia managed by the Ministry of Public Ad-
ministration. According to official data, on June 30 2017 there were 52,227 as-
sociations registered in the Register of Associations (Ministry of Public Admin-
istration, 2017). This number also includes associations which are considered
inactive because not convening assembly for more than eight years. Currently
there are even 24,440 associations in Register (46.8% of total registered asso-
ciations) that can be based on that criteria considered inactive. In the context
of the application of the Law on Association, 25,109 associations have aligned
their statutes with the provisions of the Law on Association, and for 4,637 asso-
ciations the statute is in the process of harmonization.
The number of associations as an important form of civil society organization
is an indicator of the social activities of citizens, their involvement in social pro-
cesses and the level of social capital (Putnam, 2000; Deakin, 2001 according
to Bežovan, 2002). Since the number of associations is often used as the main
indicator of civil society development, Table 1 shows the total number of asso-
ciations, the number of associations per 1,000 inhabitants, the absolute and
relative share of associations that have aligned their statutes and absolute and
relative share of associations that are officially considered inactive in the each
county of the Republic of Croatia in 2017.

7 See more: Instructions from the Central Tax Administration Office, KLASA: 410-01/15-01/1590,
URBROJ: 513-07-21-01/15-1

386
According to data from Table 1, the average number of associations per 1.000
inhabitants in the Republic of Croatia is 12.2 and ranges from 15.8 in the City
of Zagreb and the Dubrovnik-Neretva County to 9.4 in the County of Krapi-
na-Zagorje. Thereat only 35.3% of associations in the City of Zagreb have
aligned their statutes, and even 52.2% of associations are considered inactive
because not convening assembly in last eight years. In contrast, in the Krapi-
na-Zagorje County even 75.8% of associations have align its statutes, and only
37.4% of associations are considered inactive. Counties, which according to
the number of associations per 1,000 inhabitants recorded above average civil
society activity in the Republic of Croatia, excluding City of Zagreb and the
Dubrovnik-Neretva County, are: Istria, Primorje-Gorski Kotar, Osijek- Baranja,
Lika-Senj and Šibenik-Knin County. The lower level of civil society activity is re-
corded in the Krapina-Zagorje, Vukovar-Syrmia, Zagreb, Sisak-Moslavina and
Virovitica-Podravina County. The largest share of inactive associations regis-
tered in the Register of Associations was recorded in Zagreb, Šibenik-Knin and
Lika-Senj County, while in Krapina-Zagorje, Međimurje, Sisak-Moslavina and
Virovitica-Podravina County high share of associations have aligned their stat-
utes with the Law on Associations.
Of the total number of associations registered in the Register of Associa-
tions (52,227), only 33,191 associations are also registered in the Register of
Non-profit Organizations managed by Ministry of Finance of the Republic of
Croatia. This register is set up for the purpose of monitoring the financial per-
formance of non-profit organizations through the data and information from an-
nual financial statements. Given the ascertained significant number of inactive
associations, it can be concluded that the number of associations signed in the
Register of Non-Profit Organizations at the Ministry of Finance (32,542) more
realistically reflects the number of active associations today.

387
 Number of Of the total number of registered
Number of
associations Associations that
County registered Inactive
per 1.000 have aligned their
associations associations
inhabitants statutes
City of Zagreb 12,500 15.8 4,410 35.3% 6,519 52.2%
Dubrovnik-Neretva 1,934 15.8 1,032 53.4% 899 46.5%
Istria 3,008 14.5 1,298 43.2% 1,387 46.1%
Primorje-Gorski Kotar 4,082 13.8 1,909 46.8% 1,701 41.7%
Osijek-Baranja 3,896 12.8 2,392 61.4% 1,569 40.3%
Lika-Senj 647 12.7 392 60.6% 348 53.8%
Šibenik-Knin 1,344 12.3 695 51.7% 719 53.5%
Bjelovar-Bilogora 1,386 11.6 893 64.4% 656 47.3%
Koprivnica-Križevci 1,323 11.4 759 57.4% 406 30.7%
Karlovac 1,439 11.2 897 62.3% 601 41.8%
Požega-Slavonia 852 10.9 556 65.3% 369 43.3%
Split-Dalmatia 4,863 10.7 2,872 59.1% 2,525 51.9%
Zadar 1,762 10.4 824 46.8% 778 44.2%
Međimurje 1,162 10.2 841 72.4% 418 36.0%
Brod-Posavina 1,607 10.1 797 49.6% 894 55.6%
Varaždin 1,778 10.1 1,162 65.4% 612 34.4%
Virovitica-Podravina 839 9.9 596 71.0% 354 42.2%
Sisak-Moslavina 1,696 9.8 1,211 71.4% 710 41.9%
Zagreb 3,103 9.8 1,892 61.0% 1,685 54.3%
Vukovar-Syrmia 1,752 9.8 1,208 68.9% 821 46.9%
Krapina-Zagorje 1,254 9.4 951 75.8% 469 37.4%
TOTAL 52,227 12.2 27,587 52.8% 24,440 46.8%
Table 1. Number of associations in Republic of Croatia on June 30 2017
Source: Authors calculations based on data from Register of Associations of Republic of Croatia and date
from Croatian Bureau of Statistics (Population contingents, by towns/municipalities, Census 2011)

4. Economic and financial potential of citizens’ associations

in the Republic of Croatia
The analysis and assessment of the economic and financial potential of a cit-
izen’s association is based on information presented in financial statements.
Information is generated according to nonprofit accounting system of Croa-
tia which based on accrual accounting principle since 2008. According to the
Act on Financial Operations and Accounting of Non-Profit Organizations (Of-
ficial Gazette 121/2014), the reporting and accounting system is rationalized
by the size and economic importance of a non-profit organization. Accounting
methods and financial reporting vary based on the revenue and asset value of

388
certain non-profit organizations8. So called small non-profit organizations are
enabled to apply simplified cash basis accounting, while others apply accrual
accounting and the system of integrated financial reporting.
Of the total number of associations registered in the Register of Non-profit Or-
ganizations, 54% apply accrual accounting principle and are required to submit
complete set of financial statements. The remaining 46% are so-called small
associations that apply simple bookkeeping and submit only annual financial
report on receipts and expenditures at the end of the year. This complicates
an integrated overview and the analysis of the non-profit sector, because it re-
quires the reclassification of data expressed on different methodological bases.
An analysis of the overall financial performance of the associations in the Re-
public of Croatia is even more complicated due to fact that only about 70% of
associations registered in the Register of Non-profit Organization have fulfilled
their statutory obligation to submit financial reports for 2016, namely 75% of
associations applying accrual accounting and the system of integrated financial
reporting and about 65% of associations applying simplified cash basis ac-
counting. Although the percentage of associations that had fulfilled their statu-
tory obligation to submit financial reports has increased in comparison to 2015,
the degree of transparency of financial operations and financial discipline of
associations is still unsatisfactory in Croatia.
Despite the fact that only 70% of associations registered in the Register of
Non-profit Organization have fulfilled their statutory obligation to submit finan-
cial reports for 2016, the available data represents a valuable source of infor-
mation on financial aspects of the activities of associations. Nevertheless, at
the level of macroeconomic management to this group of entities is not given
adequate importance. Probably because of their low fiscal potential and rela-
tively small share of the total number of workers they employ.
Associations that are required to submit complete set of financial statements
reported in aggregate Income and Expenditure Report in 2016 total revenues
exceeding HRK 5.6 billion, or 13.7% more than in 2015 and expenditures in ex-
cess of HRK 5.4 billion which is 9% higher than in 2015. According to date from
aggregate Balance sheet, the value of the assets of associations of citizens and
their alliances in the Republic of Croatia at the end of 2016 amounts to HRK
5.26 billion, which is 4.4% higher than in the previous year.
Small associations, that apply simplified cash basis accounting, in aggregate
Report of the Receipts and Expenditures in 2016 reported receipts 17.7% high-
er than in 2015 (HRK 411.6 million) and expenditures 20.1% higher than in
2015 (HRK 400.8 million).

8 Single bookkeeping can be applied by non-profit organization whose revenue and value of as-
set does not exceed HRK 230.000 in last three years. More on non-profit accounting system in
Republic of Croatia: Vašiček, V. and Vašiček, D. (2016) „Računovodstvo proračunskih i neprofitnih
organizacija“, Ekonomski fakultet Sveučilišta u Rijeci, Rijeka

389
Human resources, especially those working for associations, are key factor for
sustainability and development of the same. Employment data (based on hours
worked) show that associations in Croatia employ a total of 18,800 workers,
which is 6.5% more than last year. This number of workers account for more
than 0.86% of the total number of employees in the Republic of Croatia9.
The 2016 summary report shows that aggregated employment data and per-
formance elements of associations and their alliances are steadily increasing,
suggesting that in economic terms, due to their non-market orientation, un-
favourable economic conditions have not adversely affected the activities of
associations in the Republic of Croatia. It should also be borne in mind that,
although since the financial reporting obligation of all non-profit entities has
been introduced in 2015, still a large number of associations do not fulfil their
obligation to register in the Registr of Non-Profit Organizations and their statu-
tory obligation to submit financial reports, making it difficult to fully analyze and
create an overall picture of economic strength of the most represented form of
civil society organizations.

5. The sustainability of citizens’ associations in

the Republic of Croatia
Certain amount of funding is necessary to cover the costs of activities of each
association. Sustainable development and long-term stability of civil society or-
ganizations are linked to possibilities of collecting necessary financial resourc-
es from different sources. Sources of financial resources required for the oper-
ation of the association are private donations of economic entities and citizens,
public grants awarded by governments, counties, cities and municipalities or
public companies and organizations, then membership fees or funds provided
by members of individual associations and the funds allocated to them from
foreign programs intended for the development of civil society (Bežovan & Iva-
nović, ny). The existence of various sources of funding associations’ activities
indicates that society has recognized the strength and important role of civil
society in the development of society. Unfortunately, most of the organizations
have one or two sources of funding, which, in the long run, imply a great finan-
cial instability of such organizations (Bežovan, 2004). In addition, the number of
sources most often depends on the area of ​​activity of an association (Bežovan
& Ivanović, ny).
In 2016, donations make up the largest proportion of sources of income for
non-profit organizations (28%), of which 60% are donations from the budget,
followed by revenue on the basis of special regulations (27%). Membership
fees account for 14% of income, while on the basis of social entrepreneurship
19% of revenue is generated (Vašiček, Sikirić & Čičak, 2017). The aforemen-
tioned indicates that the financing of the non-profit sector is mostly obtained

9 Authors Calculation based on data from Croatian Bureau of Statistics (Employed by occupation,
age and sex, by towns/municipalities, Census 2011)

390
through donations. It is noticeable that the revenues of social entrepreneurship
are relatively poorly represented, which leads to the conclusion that this form of
action needs to be stimulated through the legal and tax system.
The Regulation on the Criteria, Standards and Procedures for Financing and
Contracting Programs and Projects of Public Benefit Interest Implemented by
Associations (Official Gazette 26/15) defines the standards of financing and
measures that associations and other civil society organizations must fulfill
when implementing programs and projects of general interest financed from
public sources. One of the basic prerequisites is the registration in the Register
of Non-profit Organizations, which aims to increase financial transparency of
the operations and activities of non-profit organizations According to the Report
on the Financing of Civil Society Organizations Projects and Programmes from
Public Sources in 2015, adopted by the Government in April 2017, 36.104 dif-
ferent programs and projects of general interest implemented by associations
and other civil society organizations were financed from the public sources, and
through a public call a total of HRK 1.672.699.179,11 was awarded by direct
grants, donations and sponsorships. The amounts awarded according to the
sources of funds at all levels in 2015 are shown in Table 2.

Relative
Source of funds Amount awarded
share (in %)
Funds from the city budgets 397,157,789.76 23.74
Funds from the part of the revenues from
359,741,156.20 21.50
games of chance
Funds from the state budget 304,952,647.99 18.23
Funds from the budget of the City of Zagreb 215,041,315.26 12.86
Funds from the municipal budget 139,042,928.02 8.31
EU funds 99,907,093.72 6.00
Funds from county budget 98,226,989.68 5.87
Funds from the income of companies owned by the
Republic of Croatia and local and regional 31,236,798.32 1.86
self-government units
Funds from the part of the income of tourist boards 16,913,422.31 1.01
Funds from part of the income from the HRT fee 4,079,162.55 0.24
Funds from fees for environmental protection 3,343,477.44 0.20
Funds from other foreign funds (European
Economic Area countries and the Kingdom 2,339,624.31 0.14
of Norway)
Non-financial funds 332,400.91 0.02
Total: 1,672,699,179.11 100.00

Table 2. The amounts awarded according to the sources of funds at all levels in 2015
Source: Report on the Financing of Projects and Programs of Civil Society Organizations from
public funds in 2015 (UZUVRH 2017)

391
State administration bodies, Croatian Government offices and other public insti-
tutions at the national level financed 7,540 civil society organizations’ programs
and projects with HRK 774,747,534.86 and HRK 332,400, 9110 of non-financial
funds in 2015, which is 31.73% more than in 2014 when only 5,724 civil society
organizations’ programs and projects were financed. The largest amount of
funds, 24.1% of the total amount, was allocated to social activities. 22.5% of to-
tal funds were allocated for the activities in the field of culture and art and 17.6%
for sports projects. Most of the funds (40.36%) were awarded through a public
call/invitation. Sports competition are the most financed activity with 16% of the
total amount, followed by organizational capacity building activities with 14.06%
and activities aimed at raising the quality of life of people with disabilities with
9.64% (Office for the Cooperation with NGOs, 2017). It can be concluded that
at national level, civil society organizations’ programs and projects are increas-
ingly seen as an investment in community and development of a society as a
whole, and not as a cost.
In 2015, counties, the City of Zagreb, cities and municipalities allocated a total
of HRK 849,469,022.72, or 50.78% of total funds11. 66% of county’s funds, 75%
of city’s funds and 40% of municipality’s funds were awarded by public calls. All
counties and the City of Zagreb allocate their funds based on strategic and/or
program documents. While, only around 50% of cities and about 25% of munic-
ipalities have strategic documents based on which funds should be allocated
(Office for the Cooperation with NGOs, 2017).
5.87% of total funds were allocated from the county’s budget using which
6.068 civil society organizations projects and programs were financed, which
is 16.94% less than in 2014. 1.814 civil society organizations’ projects and pro-
grams were financed by more than HRK 215 million12 from the budget of City
of Zagreb which represents 12.86% of total public funds. The largest amount
of funds was allocated to the field of sport, almost 31% of the total public funds
from county budget and 71.55% of the total amount from the budget of the City
of Zagreb. Following is the area of culture and art, financed with a share of
20.14% of funds from county budget and with 11.39% of funds from the budget
of the City of Zagreb, and the area of social activity13 funded with 11.37% of
funds from county budget and 7.1% of total budget funds of the City of Zagreb
(Office for the Cooperation with NGOs, 2017).
From city budgets HRK 397,157,789.7614 or 23.74% of total public funds was
awarded. Using those public funds 8,721 civil society organizations projects
and programs were financed. City of Split awarded 8.37% of total amount of
funds from city budgets, City of Rijeka 6.5% and City of Dubrovnik 5.2%. 56,2%

10 46,31% of the total amount allocated from public sources.

11 In 2014 HRK 1.014.347.095,41 or more than 60% of total public funds was awarded by local
self-government units.
12 19,83% less than in 2014
13 Financial support for people with disabilities, people with special needs and socially vulnerable
groups
14 14,45% less than in 2014

392
of total funds from city budgets or HRK 223.371.963,89 is used for financing
activities in field of sport followed by activities in field of protection and secure
with share of 10,74%, and projects and programs in a field of art and culture
with 10,68%.
The largest share of funds (40.65%) were allocated for the realization of public
needs programs established by a special law. 40.21% of the funds were award-
ed through public calls. 10.1% funds are used for the implementation of public
authority entrusted by the special law. While HRK 8,283,172.66 or slightly more
than 2% of the total allocated funds were by the decision of the mayor allocated
outside the public call to unplanned activities (Office for the Cooperation with
NGOs, 2017).
From municipal budgets 8.31% of total public funds (HRK 139.042.928,02)
were allocated for implementation of 5,687 projects and programs. The highest
amount of HRK 3,505,679.50 was allocated by the Municipality of Podstrana,
which is 2.52% of the total amount of funds from State administration bodies,
Croatian Government offices and other public institutions at the national lev-
el financed 7,540 civil society organizations’ programs and projects with HRK
774,747,534.86 and HRK 332,400, 9115 of non-financial funds in 2015, which
is 31.73% more than in 2014 when only 5,724 civil society organizations’ pro-
grams and projects were financed. The largest amount of funds, 24.1% of the
total amount, was allocated to social activities. 22.5% of total funds were allo-
cated for the activities in the field of culture and art and 17.6% for sports pro-
jects. Most of the funds (40.36%) were awarded through a public call/invitation.
Sports competition are the most financed activity with 16% of the total amount,
followed by organizational capacity building activities with 14.06% and activities
aimed at raising the quality of life of people with disabilities with 9.64% (Of-
fice for the Cooperation with NGOs, 2017). It can be concluded that at national
level, civil society organizations’ programs and projects are increasingly seen
as an investment in community and development of a society as a whole, and
not as a cost.
In 2015, counties, the City of Zagreb, cities and municipalities allocated a total
of HRK 849,469,022.72, or 50.78% of total funds16. 66% of county’s funds, 75%
of city’s funds and 40% of municipality’s funds were awarded by public calls. All
counties and the City of Zagreb allocate their funds based on strategic and/or
program documents. While, only around 50% of cities and about 25% of munic-
ipalities have strategic documents based on which funds should
5.87% of total funds were allocated from the county’s budget using which
6.068 civil society organizations projects and programs were financed, which
is 16.94% less than in 2014. 1.814 civil society organizations’ projects and pro-
grams were financed by more than HRK 215 million17 from the budget of City
15 46,31% of the total amount allocated from public sources.
16 In 2014 HRK 1.014.347.095,41 or more than 60% of total public funds was awarded by local
self-government units.
17 19,83% less than in 2014

393
of Zagreb which represents 12.86% of total public funds. The largest amount
of funds was allocated to the field of sport, almost 31% of the total public funds
from county budget and 71.55% of the total amount from the budget of the City
of Zagreb. Following is the area of culture and art, financed with a share of
20.14% of funds from county budget and with 11.39% of funds from the budget
of the City of Zagreb, and the area of social activity18 funded with 11.37% of
funds from county budget and 7.1% of total budget funds of the City of Zagreb
(Office for the Cooperation with NGOs, 2017).
From city budgets HRK 397,157,789.7619 or 23.74% of total public funds was
awarded. Using those public funds 8,721 civil society organizations projects
and programs were financed. City of Split awarded 8.37% of total amount of
funds from city budgets, City of Rijeka 6.5% and City of Dubrovnik 5.2%. 56,2%
of total funds from city budgets or HRK 223.371.963,89 is used for financing
activities in field of sport followed by activities in field of protection and secure
with share of 10,74%, and projects and programs in a field of art and culture
with 10,68%.
The largest share of funds (40.65%) were allocated for the realization of public
needs programs established by a special law. 40.21% of the funds were award-
ed through public calls. 10.1% funds are used for the implementation of public
authority entrusted by the special law. While HRK 8,283,172.66 or slightly more
than 2% of the total allocated funds were by the decision of the mayor allocated
outside the public call to unplanned activities (Office for the Cooperation with
NGOs, 2017).
From municipal budgets 8.31% of total public funds (HRK 139.042.928,02)
were allocated for implementation of 5,687 projects and programs. The highest
amount of HRK 3,505,679.50 was allocated by the Municipality of Podstrana,
which is 2.52% of the total amount of funds from municipal budgets, followed
by the Municipality of Dugopolje with a share of 2.29% and the Municipality of
Kostrena with a share of 1.56%. 14 municipalities declared that they did not
allocate any public funds to civil society organizations in 2015. More than 40%
of total funds from municipal budget were allocated for the activities in the field
of sport, 26.12% for the activities in the field of the protection and secure, while
projects and programs in the field of culture and art were financed by 13.90% of
total amount of funds (Office for the Cooperation with NGOs, 2017).
142 companies owned by the Republic of Croatia and local and regional
self-government units funded 2,231 projects with more than HRK 31 million.
More than 80% of donations and sponsorships came from companies owned
by the Republic of Croatia, such as Hrvatska elektroprivreda d.d. with 74,5%
of total amount, INA d.d. with 7,4% and Croatian bank for reconstruction and
development with 6.3%. Among the companies owned by local self-govern-
ment units, i.e. cities and municipalities, the highest amount was awarded by

18 Financial support for people with disabilities, people with special needs and socially vulnerable
groups
19 14,45% less than in 2014

394
Zagrebački holding (26.4%), followed by Vodovod i odvodnja Šibenik d.o.o.
(10.37 %), GKP Komunalac d.o.o. (3.36%) i Montraker d.o.o. Vrsar (3,36%).
Most of the funds were awarded in the form of sponsorships, to be exact more
than HRK 18 million, predominantly to the field of sport, followed by the area of
social activity, and the area of culture and art (Office for the Cooperation with
NGOs, 2017).
Most of the donations and sponsorships from the public companies are not
awarded on the basis of strategic documents and in 2015 only a few companies
awarded their donations on the basis of a public call, considering that the pre-
scribed standards of planning, allocation and monitoring of allocated funds do
not apply for them, which indicates a low level of awareness of need for trans-
parent spending of public funds in public companies (Office for the Cooperation
with NGOs, 2017).
36 tourist boards awarded 1.01% of total allocated funds from public sources
for implementation of civil society organizations projects and programs in the
field of tourism. The highest amount was awarded by the Tourist Board of the
City of Zagreb with a share of 65.42%, followed by Croatian National Tourist
Board (8.71%), Tourist Board of the City of Poreč (with a share of 5.66%), Tour-
ist Board of the Municipality of Medulin (3.89%), Pula Tourist Board (2.44%)
and the Split-Dalmatia County Tourist Board (2.25%) (Office for the Coopera-
tion with NGOs, 2017).

6. Conclusions
The development of a civil society, as part of a non-governmental non-profit
sector, is one of the key indicators of the degree of development of a country’s
democracy. In addition, citizens’ associations with their multitude and heter-
ogeneity of activities represent the fundamental infrastructure of civil socie-
ty and are the dominant part of the non-governmental non-profit sector. Due
to countries, particularly transitional and post-transitional countries, dedicate
special attention to institutional and legislative creation of conditions for their
establishment and operation which is reflected in the creation of a broad and
liberal legal framework, certain tax benefits, institutional support and public
funding. Although citizen’s associations operate predominantly on volunteer
basis, the viability of the activities of citizen associations and other non-gov-
ernmental non-profit organizations is conditioned by the availability of appro-
priate economic and financial resources. Citizens’ association’s sources of
funds vary and, in accordance with their non-market and non-profit orientation,
are only to a lesser extent generated on the market in the sphere of social
entrepreneurship.
The development, performance and importance of the non-profit sector is pri-
marily evaluated by non-financial, qualitative criteria of their influence on polit-
ical decisions and their contribution to the development of society as a whole,
while systematic monitoring of economic and human potential and financial

395
sustainability of citizen’s associations is absent. The research results present-
ed in this paper show a significant number of citizens’ associations and signif-
icant regional diversity of their activity in relation to the number of inhabitants.
Also, research results show that the degree of financial discipline and formal
legal arrangements are still low. This is reflected in the disproportion of the total
number of registered associations in relation to the number of associations that
have aligned their statues with the Law on Association and a significant number
of associations that did not fulfill their statutory obligation to submit financial
statements. These facts make comprehensive economic financial analysis of
the entire group of associations difficult. However, available data show that
associations represent a respectable socio-economic segment in the Repub-
lic of Croatia. Annual revenues and assets of this group of legal entities are
continuously increasing and continuously exceed HRK 5 billion, while effective
employment, expressed in hours of work, reaches almost 1% of the total num-
ber of employees in the Republic of Croatia. Although to a large extent based
on voluntarism and private sources of funding, public funds still represent the
most important source of financing civil society organizations activities. While
income from social entrepreneurship is still underrepresented, pointing to the
conclusion that this form of action is necessarily to more systematically stimu-
late through the legal and tax system.

396
REFERENCES

Act on Financial Operations and Accounting of Non-Profit Organizations (Offi-

cial Gazette 121/2014)

Bežovan, G. & Ivanović, M. (ny) Razvoj civilnog društva u Hrvatskoj, UNDP

Croatia, Zagreb, Available at: http://programjako.info/wp-content/up-
loads/2009/01/UNDP_RazvojCivilnogDrustvaUHrvatskoj.pdf, [Accessed:
March 15, 2017]

Bežovan, G. (2002) “Struktura civilnog društva u Hrvatskoj”, Politička misao,

Vol. 39 No. 1, pp. 63-87

Bežovan, G. (2004) Civilno društvo, Zagreb: Nakladni zavod Globus

Croatian Bureau of Statistics (ny) Sektorska klasifikacija institucionalnih jedini-

ca, (S.13), Available at: http://www.dzs.hr/app/sektorizacija/Documenta-
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Croatian Bureau of Statistics (ny) Employed by occupation, age and sex, by

towns/municipalities, Census 2011, Available at: http://www.dzs.hr/Hrv/
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Croatian Bureau of Statistics (ny) Population contingents, by towns/municipal-

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European Commission (2013) European system of accounts - ESA 2010, Clas-

sification of the purposes of non-profit institutions serving households
(COPNI), Available at: http://ec.europa.eu/eurostat/web/products-manu-
als-and-guidelines/-/KS-02-13-269, [Accessed: March 15, 2017]

Law on Association (Official Gazette 74/17, 70/17)

Ministry of finance of Republic of Croatia: Instructions from the Central Tax

Administration Office, KLASA: 410-01/15-01/1590, URBROJ: 513-07-
21-01/15-1

Ministry of Public Administration (2017) Statistički prikaz Ministarstva uprave broj

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Office for the Cooperation with NGOs (2017) Izvješće o financiranju projekata i pro-
grama organizacija civilnoga društva iz javnih izvora u 2015. godini, Avail-
able at: https://udruge.gov.hr/UserDocsImages/dokumenti/Izvjesce%20
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Regulation on the Criteria, Standards and Procedures for Financing and Con-
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by Associations (Official Gazette 26/15)

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Budget and Budget and Extra-budgetary Users of the Budget of Local
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Vašiček, D.; Sikirić, A.M., and Čičak, J. (2017) Economic and financial aspects
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398
 CHAPTER 24

Constructing financial statements and the framework

of accounting

Lidija Romic1

ABSTRACT

This paper introduces each of the principal financial statements, beginning with the Prof-
it and Loss account and Balance Sheet. It begins with an overview of the regulations
governing financial statements and describes the matching principle, which emphasizes
prepayments, accruals and provisions such as depreciation. Accounting provides an
account – an explanation or report in financial terms – about the transactions of an or-
ganization. Accounting enables managers to satisfy the stakeholders in the organization
(owners, government, financiers, suppliers, customers, employees etc.) that they have
acted in the best interest of the stakeholders rather than themselves.
This explanations are provided to stakeholders through financial statements or reports,
often referred to as the company’s accounts’. The main financial reports are the Profit
and Loss account, The Balance Sheet and the Cash flow statement.
The presentation of financial reports must comply with Schedule 4 to the Companies
Act, 1985, which prescribes the form and content of accounts. Section 226 of the Act
requires the financial reports to represent a ‘true and fair view’ of the state of affairs of
the company and its profits. The companies Act requires directors to state whether the
accounts have been prepared in accordance with accounting standards and to explain
any significant departures from those standards. For companies listed on the Stock
Exchange, there are additional rules contained in the Listing Requirements, commonly
known as the Yellow Book, which requires the disclosure of additional information.

Key words: accounting, financial statements, profit, loss, cash flow

Jel Classification: M 53

1. Introduction
There is a legal requirement for the financial statements of companies (other
than very small ones) to be audited. Auditors are professionally qualified ac-
countants who have to conduct an audit – an independent examination of the
financial statements – and form an opinion as to whether the financial state-
ments form a true and fair view and have been prepared in accordance with the
Companies Act.

1 University od Novi Sad, Faculty of economics Subotica

399
Although the requirement for a true and fair view is subjective and has never
been tested at law, it takes precedence over accounting standards.
Accounting standards are principle to which accounting reports should con-
form. They are aimed at:
-- Achieving comparability between companies, through reducing the vari-
ety of accounting practice:
-- Providing full disclosure of material (i.e. significant) factors through the
judgements made by the preparers of those financial reports, and
-- Ensuring that the information provided is meaningful for the users of fi-
nancial reports
However, a criticism of the standards is that they are set by the preparers (pro-
fessional accountants) rather than users (shareholders and financiers) of finan-
cial reports.
Financial Reporting Standards (FRSs) are issued by the Accounting Standards
Board (ASB) and Statement of Standard Accounting Practice (SSAPs) were Is-
sued by the Accounting Standards Committee, which preceded the ASB. FRSs
and SSAPs govern many aspects of the presentation of financial statements
and the disclosure of information (for a detailed coverage, see Blake, 1997)
Examples of commonly applied standards include:
SSAP9 Stocks
SSAP13 Research and Development
SSAP21 Leases
FRS10 Goodwill
FRS12 Provisions
FRS15 Fixed Asset and Depreciation
A Financial reporting Review Panel has to power to seek revision of a compa-
ny’s accounts where those accounts do not comply with the standards and if
necessary to seek a court order to ensure compliance.
Interestingly, the US equivalent of the true and fair view is for financial state-
ments to be presented fairly and in accordance with Generally Accepted Ac-
counting Principles (or GAAP). There is a move towards the harmonization of
accounting standards between countries through the work of the International
Accounting Standard Board (IASB). This has been a consequence of the glo-
balization of capital markets, with the consequent need for accounting rules
that can be understood by international investors. The dominance of multina-
tional corporations and the desire of companies to be listed on several stock
exchanges have led to the need to rationalize different reporting practices in
different countries. In Europe, all listed companies of member states of the
European Union have to comply with IASB standards by 2005.

400
2. Literature review
1. Akerlof, G. (1997) Allard J. (2006)
2. Applebaum, S.H. and Mousseau, H. (2006)
3. Breton, G. and Taffer R. (1995)
4. Buckley, C., Cotter D., Hutchinson, M. and O’ Leary, C. (2010)
5. Coase, Ronald (1937)
6. Conford A. (2004)
7. Derry Cotter (2012)
8. Daynard, R A, Bates C. and Francey, N. (2000)
9. Glazer, M .(1983)
10. Griffiths I. (1986)
11. Hope, A. and Gray, R. (1982)
12. Joss. P. H. Tompkins, M.E and Hays, S.W. (1989)
13. Jensen, Michael and Meckling, William (1976)
14. Johnson, S.A., Moorman T.C. and Sorescu S.M. (2009)
15. Miller A.D. (2010)
16. Munzing P.G. (2003)
17. Nasser K.H.M. (1993)
18. Nadler J. and Schulman M. (2006),
19. Near J.P. (1989)
20. Parmerlee. MA Near J.P. and Jensen T.C. (1982)
21. Paul, R. J. and Townsend J.B. (1996)
22. Vasella, D. (2002)
23. Watts, R. and Zimmerman, J. (1978)
24. Wall Street Journal (2002)
25. Zeff, S. (1978)

3. Metodology
Management is responsible for the preparation of financial statements and
therefore plays a key role in the financial reporting regulatory environment. This
is reflected in Figure 1. Derry Cotter (2012)
One could view management’s role as being simply to report objectively in ac-
cordance with the various regulatory requirements. In doing so, management
may nonetheless exercise accounting policy choice in a manner that is in its
own interests or that of the entity. For example, in a time of rising property
prices, profit could be increased by using the fair value model to account for
investment property.

401
Watts and Zimmerman (1978) have used positive accounting theory (PAT) to
explain management’s choice of accounting policies. PAT contains three hy-
potheses:
-- Bonus plan hypothesis. Management whose bonuses are based on ac-
counting profits are likely to use accounting policies that increase profit,
-- Debt: equity hypothesis. Firms with high level of borrowing are likely to
use accounting policies that increase profit. This will assist highly geared
firms to meet lending conditions such as the time interest covered ration
( i.e. profit before interest/interest) and thereby avoid penalties.2

Figure 1. Factors determining the content of financial statements Derry Cotter (2012)

3.1. Size hypothesis

Large firms are more likely to use accounting policies that reduce profit, so as
to avoid any unfavourable attention that high profits might attract (e.g. oil com-
panies may want to avoid government controls on petrol prices).
Management may also decide to employ creative accounting techniques for
any of the following reasons:
-- To reduce taxation,
-- To control dividends,
-- Pressure from analysts and big institutional investors to meet profit tar-
gets and
-- Big bath theory, which maintains that new management will maximize
losses and blame them on their predecessors. This should result in the
new management taking credit for improved results going forward.
It is essential when accounting standards are being developed, that regulatory
bodied such as the IASB are fully cognizant of management’s part in the pro-
cess. As outlined above, when preparing financial statements management will
seek to achieve objectives that are in their own interests and that of their firm.
Through their interpretation and application of accounting standards, and their

2 Wall Street Journal (2002) Elan’s revenue gets a quick lift from its complicated accounting
29 January

402
choice of accounting policies, management plays a critical role in the prepara-
tion and presentation of financial statements. By being aware of the factors that
influence and motivate management, the IASB can be more effective in fulfilling
their regulatory function.
The foregoing discussion has focused on the issues that determine the content
and presentation of an entity’s financial statements. So as to fully appreciate
the role of the regulatory process, it is also important to understand the impact
which financial statements have on the various user groups and on society in
general. This impact is outlined in Figure 2. Derry Cotter (2012)

3.2. Economic consequences

Throughout most of the twentieth century, business corporations were benignly
regarded as the primary drivers of wealth creation. Accountability was rarely an
issue, as employees and other stakeholders offered unconditional loyalty to the
corporate ethos. An example was the US tobacco industry which though raising
serious health concerns since 1950s, did not succumb to the first successful
legal action until 1996 .Daynard R a, Bates C. and Francey, N (2000)The in-
dustry’s primary defence during that time was to blame smokers for choosing
to use their products despite the known risks.
Zeff S. (1978) however, explains how in the 1970s, society began to hold its in-
stitutions responsible for the social environmental and economic consequenc-
es of their actions. A prime example was the Challenger space shuttle disaster
in 1986, which resulted in the deaths of all seven crew members. The Rogers
Commission which investigated the accident was critical of NASA’s safety cul-
ture, and the US House Committee on Science and Technology concluded that
the fundamental problem was poor technical decision-making by top NASA and
contractor personnel.

Figure 2. Impact of financial statements Derry Cotter (2012)

403
A similar culture of accountability has evolved in the area of financial regulation.
For example in 2000, theUK standard setting body, the ASB was held partially
responsible when employers began to replace defined- benefit pension plans
with defined-contribution plans. The change resulted in a transfer of risks to
employees, as employee pension under defined-contribution plans depend on
the future performance of fund assets, rather than being guaranteed by em-
ployers. The allegation against the SB arose from the publication of FRS 17,
Retirement Benefits, which required that pension scheme deficits should be
recognized immediately as a liability, rather than being amortised over the ex-
pected service lives of employees in the scheme. This requirement meant that
pension deficits crystallised immediately in the financial statements, making
defined- contribution plans less attractive from an employer’s perspective.
As noted previously, the IASB’s requirement for financial assets to be stated at
fair value was widely perceived as contributing to the recent global financial cri-
sis. This requirement was relaxed after the IASB came under intense pressure
from international governments.
Thus, it is generally accepted that financial statements have significant eco-
nomic consequences.3

3.3. Stock market efficiency

Stock market efficiency is assessed by the speed and accuracy that share pric-
es reflect new information. Many studied have shown that share prices react
to new accounting information, which confirms that published financial state-
ments contribute to stock market efficiency. Thus, financial statements have an
important role in ensuring that quoted share prices reflect the fair value of an
entity’s securities.

3.4. Compliance
Financial statements play a crucial role in enabling businesses to fulfill their
statutory obligations. This includes the submission of tax information to the
revenue authorities, the furnishing of annual financial statements to sharehold-
ers, the fulfillment of a company’s audit requirement, and the filing of an annual
return with the Companies Registration Office or similar authority.

3.5. Decision making

Financial statements serve as a valuable tool for decision making purposes,
such as the purchase and sale of shares. They are also used by lending institu-
tions when assessing credit applications, by creditors when evaluating orders
for goods or services, by governments when allocating grants and subsidies
and by trade unions as part of the wage-negotiation process.

3 Near J.P (1989) Whistleblowing:encourage it. Business Horizons 32 (1) pp.2-7

404
4. Empirical data and analysis
Creative accounting can be defined as the presentation of information in a
manner that is inconsistent with the underlying facts. It has been a problem
throughout the twentieth century and continues to challenge regulators into the
new millennium. Madbid.com provides a good example of how numbers can
be presented in a creative way. On the Madbid website, the BBC is quoted as
saying that Goods can be won for a fraction of their retail price. The Times is
quoted as saying that the average saving on high street prices is 98%. A closer
examination of the Madbid website reveals a somewhat different story. Bids
which have a face value of 1 cent, cost up to 33 cents each to purchase from
Madbid. During an auction the price of an item increases by 1 cent every time
that someone places a higher bid. However the cost of placing a bid that is 1
cent higher varies between 25 and 33 cents.
For example the Madbid website features an Audi 1.2 Sportback which was
auctioned for 2529 € in January 2011. The total amount paid by bidders (only
one of whom could win) was between 63225€ (i.e.25 x 2529€) and 83457€
(i.e 33x 2529€) based on a listed recommended retail price of 16320€, Madbid
earned a profit of at least 46905€, and possibly as much as 67137€ from the
auction of the Audi.
Creative accounting can have significant economic consequences. For exam-
ple, if it is used to reduce a firm’s tax charge, there is a transfer of resources
from society to the firm. If creative accounting is used to overstate a firm’s
share price, there will be a transfer of resources from investors to the firm when
new shares are issued. Share price overstatement will also result in investors
who are selling the company’s shares benefiting at the expense of buyers. If
management uses creative accounting techniques to maximize their level of re-
muneration, there is a transfer of resources from shareholders to management.

4.1. Reasons for creative accounting

There are many reasons that provide an incentive for management to engage
in creative accounting. Watts and Zimmerman’s (1978) positive accounting the-
ory maintains that management is influenced by:
• The size hypothesis
• The debt/equity hypothesis
• The bonus plan hypothesis
The size hypothesis argues that large firms may want lower profits so as to
avoid unfavourable political costs, such as government-imposed price restric-
tions on their products or services. Firms with high debt/equity ratios may wish
to increase their profits in order to comply with loan agreements, which typically
require profits to be a certain multiple of the interest charge for the period.
Thirdly, management may be motivated to increase their firm’s profit where
managerial bonuses are based on accounting earnings.

405
The big bath theory provides another rationale for the use of creative account-
ing practices by management. This involves new management maximizing a
firm’s losses immediately following their appointment. The objective is to hold
their predecessors responsible, while allowing the new management to take
the credit for enhanced future profits. In this paper we reports on the reasons
given by auditing practitioners and management for the use of creative ac-
counting practices. These are summarised as follows:
-- To meet the limits on borrowing and gearing
-- Desire to reduce taxation
-- Desire to control dividends
-- Pressure from big institutional investors

4.2. Examples of creative accounting

There are many examples of creative accounting practices. Some of these are
discussed below:
(i) Obfuscation hypothesis
This involves communicating good news with clarity and the use of short
words. Bad news, on the other hand, is communicated in a manner that
is more difficult to comprehend. The use of obfuscation is most com-
monly found in those parts of the annual report that involve a significant
amount of narrative, such as the Chairman’s Statement.
(ii) Earnings management
The earnings management literature outlines how management may en-
gage in income smoothing practices so as to reduce the risk perception
of their firm:
1. Smoothing through allocation over time. Management can manipu-
late the periods in which expenses are recognized. For example, the
useful life of assets can be adjusted, thereby affecting the amount of
depreciation charged as an expense.
2. Use of discretionary accruals. Income can also be smoothed by the
use of discretionary accruals. For example, management can deter-
mine the amount to be provided as a provision for bed debts, or the
amount of a provision in respect of a warranty on a company’s prod-
ucts or services
(iii) Off - balance sheet financing
This involves a firm’s debt being committed from its statement of finan-
cial position. This was the main creative accounting technique employed
by Enron, prior to its bankruptcy in 2001. Using other companies, called
special purpose vehicles (SPVs), Enron raised enormous amounts of
debt funding. Although Enron exercised control over these SPV’s, the

406
 loans raised by them were not included in the statement of financial posi-
tion of the Enron Group. This had the effect of significantly understating
the amount of loans outstanding.
(iv) Revenue recognition
There are many ways in which companies can use creative accounting
techniques to recognize revenue before it is earned. One such practice,
known as channel stuffing, involves a distributor supplying more goods
to retail outlets that can be sold to customers. The distributor records
these goods a revenue, thereby inflating profits, but the goods are later
returned by the retailers as they cannot be sold.
Another technique to distort revenue has been employed by the pharma-
ceutical company Elan. This practice which involved the sale of product
lines, was uncovered by the Wall Street Journal in 2002. For example,
when Elan was selling the rights to a drug called Permax for $ 47.5M, it
recorded the sale as part of product revenue. This gave the impression
that Elan’s drug sales for the period had increased by $ 47.5M, whereas
in fact this increase related to the disposal of an asset. The correct treat-
ment would have been to record the proceeds of $ 47.5M separately as
Profit on disposal of a product line and to ensure that this amount was
excluded from revenue in the income statement.
(v) Overstating assets
This involves the failure by a firm to record impairments relating to the
value of assets such as machinery, property, inventory, investments and
receivables.
(vi) Aggressive capitalization of costs
Some firms may decide to capitalize costs (e.g. research development)
which others write off routinely.

4.3. How effective is creative accounting?

The jury is still out on this question. An increase in a company’s earnings
might be achieved by using longer asset lives, resulting in a lower depreciation
charge. As this can be easily observed, however, the users of the firm’s finan-
cial statements are unlikely to be misled. Some creative accounting techniques
are not easy to spot however. For example, Enron’s use of off- balance-sheet
financing was difficult to detect, even for the company’s auditors.
It has also been found that financial analysts, who have expertise in interpreting
companies’ financial statements, may not always be able to detect a firm’s use
of creative accounting. (see Breton and Taffler 1995). Likewise, Naser (1993)
documents the case of the UK conglomerate, Polly Peck, whose impending
demise was camouflaged by the use of creative accounting techniques.

407
4.4. How can creative accounting be prevented
It is unlikely that creative accounting can ever be eliminated entirely. A number
of approaches can however, be effective in reducing its incidence.

4.5. Financial regulation

Legislation provides the basic weaponry in the war against creative accounting.
In prescribing the statutory regulations that must be complied with, the compa-
nies’ Acts establish a solid platform for the prevention of creative accounting.
Legislative requirements have also become more onerous since the collapse
of Enron in 2001. For example the Sarbanes-Oxley Act enacted in the United
States in 2002, requires compliance with a rigorous set of new rules.4
Financial reporting standards also have a crucial role to play. Regulatory bod-
ies, such as the IASB, are constantly revamping their accounting standards in
order to combat creative accounting. There is for example a continuing effort
to make accounting rules more uniform, so as to reduce the flexibility for firms
to engage in creative accounting practices.

4.6. Monitoring enforcement and penalties

An external audit of a company’s financial statements plays a crucial role in the
prevention of creative accounting. This involves an independent assessment to
determine whether the financial statements give a true and fair view of a com-
pany’s performance and financial position.
In the post-Enron world, a large number of additional policing bodies have been
established worldwide, to monitor and enforce companies’ accounting and le-
gal requirements. These include oversight bodies which monitor the conduct of
the accounting and auditing professions.
Harsher penalties can act as a deterrent against breaches of regulatory rules. A
prime example is the 25-year prison sentence passed down to Bernie Ebbers,
former CEO of WorldCom. Ebbers was convicted of fraud and conspiracy in
2005, as a result of WorlCom’s false financial reporting which resulted in a loss
of $100 billion to investors.

4.7 .Corporate governance

Adherence to a Corporate Governance Code can enable a company to estab-
lish appropriate structures to prevent the use of creative accounting practices.
For example, the appointment of a majority of non-executive directors on a
company’s board acts as a control against abuses by management. Corporate
governance is discussed in further below.

4 Nadler J. and Schulman M (2006), www.scu.edu/ethic

408
4.8. Focus on ethics
An emphasis on ethics in education can also play a significant role in helping
to reduce the use of creative accounting practices by management. This is dis-
cussed in greater detail below.

4.9. Creating a culture of whistle-blowing in organizations

Insiders are often aware of creative accounting practices long before they
become known to those outside an organization. Management can help to
eradicate creative accounting practices by providing support for a culture of
whistle-blowing in their organization. This can assist in bringing accounting ir-
regularities to light at an early stage. Whistle-blowing is discussed in greater
detail below.5

4.10. Corporate social reporting

Creating a culture of good citizenship in an organization helps to extend man-
agement’s focus beyond the needs of the shareholder/investor group. Thus, a
commitment to corporate social reporting makes management reportable to a
broader range of stakeholders, thus reducing the motivation to engage in crea-
tive accounting. This is discussed in greater detail below.
Corporate governance is defined by the Australian Stock Exchange as the
system by which companies are directed and managed. It influences how the
objectives of the company are set and achieved, how risk is monitored and
assessed, and how performance is optimized.
Munzing (2003) outlines how the need for corporate governance is directly
linked to the separation of ownership and management. Essentially, it involves
a manager (i.e. the agent) raising capital from shareholders (i.e. the principal)
for the purpose of investing in a company. The shareholders need the manager
to generate a return on the funds invested, but have no guarantee that their
funds will not be expropriated or used for projects that involve an excessive
level of risk. This dilemma is described as the agency problem The agency
problem involves what is known as oral hazard, which exists when one party
is responsible for the interests of another but has an incentive to put his or her
own interests first. For example, a manager may have an incentive to invest in
high risk projects knowing that, should the investment fail, it is the shareholders
who will suffer a loss of capital.
Contracts are therefore drawn up between the agent and principal, with a view
to ensuring that the agent’s actions are in the best interests of the principal. For
example, management remuneration levels might be based on corporate earn-
ings, or significant investments of capital in individual projects might require
prior shareholder approval.

5 Near J.P (1989) Whistleblowing:encourage it. Business Horizons 32 (1) pp.2-7

409
A key objective of corporate governance is therefore to ensure that contracts
between management and shareholders are implemented effectively. The role
of corporate governance, however, extends beyond that of establishing and
monitoring between managers and shareholders.
The modern corporation is seen to have broader societal responsibilities which
include a commitment to a code of ethical behavior and good citizenship. The
role of corporate governance therefore extends to ensuring that corporation
also fulfill their commitments to stakeholders such as employees, suppliers of
goods and services, conservationists and other interest groups who have a
valid claim on an entity’s resources.
The following statement Johnson illustrates the group’s commitment to corpo-
rate governance:
The values embodied in Our Credo guide the action of the people of the John-
son family of Companies at all levels and in all parts of the world. They have
done so for more than 60 years. These Credo values extend to our account-
ing and financial reporting responsibilities. Our management is responsible for
timely, accurate, reliable and objective financial statements and related infor-
mation. As such:6
1. We maintain a well- designed system of internal accounting controls,
2. We encourage strong and effective corporate governance from our
Board of Directors,
3. We continuously review our business results and strategic choices,
4. We focus on financial stewardship.

4.11. Corporate governance failures

The most infamous case of corporate governance failure involved the US pow-
er giant Enron, which filed for bankruptcy in 2001. Enron was the seventh larg-
est company in the United States, and its collapse, which also took down its
auditors Arthur Andersen, sent shock waves thorough the entire community.
Munzing (2003) identifies the following corporate governance failures in Enron:
1. Management was not acting in the best interests of shareholders, which
in effect was a manifestation of the principal-agent problem.
2. Management used sophisticated techniques to produce misleading fi-
nancial results
3. Due to the lack of board independence ( Enron management had a major
board presence) management was able to extract excessive remunera-
tion at the shareholders’ expense.

6 Johnson, S A, Moorman T.C and Sorescu S.M. (2009) A reexamination of corporate governance
and equity prices with updated and supplemental results. The Review of Financial Studies 22 (11)
pp 4753-786

410
An additional problem was that Enron insisted on investing its employees’ pen-
sion funds in the company’s own equity shares. This failed to provide the em-
ployees with an acceptable level of risk diversification resulting in widespread
hardship when the stock price collapsed.7

4.12. Policy response to corporate governance failures

There was a widespread regulatory response to the failure of Enron and the
subsequent demise of other companies such as WorldCom ( the largest bank-
ruptcy filing in US history prior to Lehman Brothers in 2008) The most important
policy response has arguably been in the US where the Sarbanes-Oxley Act
was passed in the summer of 2002. Provisions of the act include the prohibition
of insider lending to a firm’s executives and directors penalties for accounting
restatements reflecting misconduct and a requirement that members of audit
committees be independent. The act also strengthens auditor independence by
limiting the scope of non-audit and consulting services for audit clients. Corn-
ford (2004)
Other jurisdictions also have corporate governance codes. For example. The
UK Corporate Governance Code, which is based on principles rather than
rules, sets out best practice guidelines. Companies listed on a stock exchange
must explain if they do not comply with the provisions of the UK Corporate
Governance Code.

4.13. Does corporate governance increase shareholder value?

One rationale for the increased focus on corporate governance in recent years
is that improved monitoring leads to an increase in a company’s share price.
Another is that it reduces excessive risk-taking. There is a little empirical sup-
port, however, for the above hypotheses, and several studies have found no
significant linkage between corporate governance and the level of shareholder
wealth Johnson (2009).
In the absence of an established benefit to shareholders, Miller (2010) poses
the question as to why firms are willing to commit resources to improve cor-
porate governance. Perhaps, Miller suggests, it is because benefits from an
enhanced corporate governance may actually accrue to a wider set of stake-
holders than shareholders. It is also likely that the increased focus on corporate
governance is not voluntary, a regulatory changes may have left firms with no
option but to take corporate governance issues more seriously than therefore.8

7 Jensen, Michael and Meckling, William (1976) Theory of the firm; managerial behavior, agency
costs and ownership structure, Journal of Financial economics, 3 pp. 305-60
8 Hope, A and Gray, R (1982) Power and policy making: the development of an R&D standard,
Journal of Business Finance and Accounting, Vol. 9, No.4 Winter,pp 531-58

411
4.14. Whistle blowing
Whistle-blowing has been defined by Nadler and Schulman (2006) as calling
attention to wrongdoing that is occurring within an organization. Management
can aid the early detection of creative accounting in their organization by en-
couraging a culture that encourages and supports whistle-blowing.
Whistle-blowing has however, had a difficult evolution. Boatright (2003) de-
scribes how in a 1071 speech, James M. Roche, then chairman of the General
Motors Corporation, attacked the process of whistle-blowing:
Some of the enemies of business now encourage an employee to be disloyal
to the enterprise. They want to create suspicion and disharmony, and pry into
the proprietary interests of the business. However this is labeled-industrial es-
pionage, whistle-blowing or professional responsibility – it is another tactic for
spreading disunity and creating conflict.
Glazer (1983) identified 10 cases of whistle-blowing and examined the per-
sonal consequences for each of the whistle-blowers. The cases include that of
Justin Rose who has hired as an in-house attorney in 1973 by Associated Milk
Producers Incorporated where he quickly became aware of illegal payments
being made to politicians. 9
Parmarlee and others (1982) surveyed 72 women who had filed complaints
of unfair discrimination with Wisconsin’s Equal Rights Division. Following their
complaint, the woman reported being excluded from staff meetings, suffering
a loss of perquisites, receiving less desirable work assignments, obtaining a
heavier workload, having their work more stringently criticized and being pres-
sured to drop their action. Similarly, in survey of other whistle-blowers, Jos and
others (1989) found that 69% of those in the private sector and 59% of those
in the public sector lost their jobs. Others, in the same survey, experienced a
reduction of responsibilities or salary, or suffered harassment or work transfer.
These cases demonstrate that, traditionally, whistle-blowers have frequently
met with severe retaliation by their own organizations. This is likely to be a
response to the uncertainty that whistle-blowers create, and retaliation may be
intended to silence the perpetrator, or prevent the complaint from being made
public. It may also be intended to discredit the whistle-blower, or to deter others
from complaining in the future. 10

4.15. Changing attitude towards whistle-blowing

Zeff (1978) explains how in the 1970s, the traditional view of organizations
began to change. Hitherto seen as providers of employment and creators of
wealth, in the 1970s organizations began to be held responsible for the social,

9 Griffiths I (1986) Creative accounting London: Unwin Hyman Limited

10 Glazer, M (1983) Ten whistleblowers and how they fared, The hasting Center Report, 13 (6) pp.
33-41

412
economic and environmental consequences of their transactions. The late
1970s saw an explosion of lawsuits in the United States, and huge awards were
made against companies, resulting in an insurance crisis as insures refused to
provide an adequate level of product liability cover.
Referring to ill fated Challenger space shuttle flight in 1086, Near (1989) out-
lines how Morton Thiokol manufactures of the defective O-rings in the boost-
er rockets had ignored the pre-flight protest of one of their engineers. As a
result of the crash, Morton Thiokol faced lawsuits from the families of the
seven astronauts who died, and were forced to withdraw from future bids for
NASA contracts.
As companies were made more accountable for their actions, the attitude to-
wards whistle-blowers also began to change. Gradually, whistle-blowing be-
came more acceptable and various authors began to expound its virtues.
Boyle (1990) explains how the actions of whistle-blowers can benefit society:
The potential negatives of organizational power and generally kept in check by
a combination of market forces and government regulation. However, situations
occur that the market and government are not able to correct before society
is adversely impacted. In these situation it is incumbent upon the individual to
intercede (i.e. blow the whistle) on behalf of the common good.11
Paul and Townsend (1996) advise to create an atmosphere of trust in an or-
ganization, thereby encouraging employees to report wrongdoing without fear
of reprisal. Allard (2006) maintains that organizations without reporting mech-
anisms, such as whistle-blower hotlines, suffer fraud-related losses that are
more than twice as high as those which employ such mechanisms.12
Arguably the most famous whistle-blower is Sherron Watkins who, as Vice
president of Corporate Development is credited by many as having exposed
the Enron scandal in 2001. Her actions, which uncovered numerous unaccept-
able practices, have been an influential factor in elevating the whistle-blower to
a figure who is not merely socially responsible but who can also add value to
a company.13

4.16. Legislative support

As the perception of the whistle-blower’s role has continued to improve, leg-
islative changes have also offered support. The Sarbanes-Oxley Act, enacted
in the United States in 2002 contained measures designed to protect whis-
tle-blowers against retaliation by employers. The Whistleblower Protection Act
was enacted in the United States in 2007, and was further amended in 2009.

11 Derry Cotter (2012) Prentice Hall Pearson

12 Nadler J. and Schulman M (2006), www.scu.edu/ethic
13 Conford A (2004) Enron and internationally agreed principles for corporate governance and the
financial sector, G-24 Discussion Paper Series, No 30 June

413
There have, however also been setbacks in the regulatory area with the US Su-
preme Court in the case of Garcetti v. Cerballos (2006) ruling that government
employees did not have protection from retaliation by their employers under the
First Amendment of the Constitution .14

4.17. Results of empirical studies

Applebaum and Mosseau (2006) report that 44% of non management em-
ployees do not report misconduct that they observe. Similarly Gurchiek (2006)
maintains that only 47% of individuals are likely to report unethical activities
that occur in the workplace. Buckley and others (2010) reported a generally
positive attitude to whistle-blowing among the employees of an Irish financial
services company. They also found that employees cited a sense of responsi-
bility to their organization as a significant reason for not whistle-blowing. This
suggests that organizations need to be more active in espousing the advantag-
es of whistle-blowing if their employees are to be convinced of its benefits. A
further finding of the same study was that female employees are more willing to
whistle-blow than their male counterparts.15

4.18. Corporate social reporting

Corporate social reporting (CSR) can be defined as a concept whereby compa-
nies integrate social and environmental concerns in their business operations
and in their interaction with their stakeholders on a voluntary basis. ( European
Commission)
CSR can help to protect the environment conserve natural resources and en-
courage companies to address and resolve societal issues. It can however,
also contribute to profitability by boosting a firm’s competiveness. The 2008 Eu-
ropean Competiveness Report found that CSR can have a positive impact on
six different components of competiveness: cost structure, human resources
customer perspective, innovation capacity, management of risk and reputation
and financial performance.
In her book Just Good Business, Kellie Mc Elhaney describes how Darell Mey-
ers, Wall- Mart employee, suggested that light bulbs should be removed from
the company’s vending machines. His idea was adopted, resulting in savings of
more than $ 1 million dollars a year.
CSR can also help to establish a reputation for good citizenship, which can be
a valuable asset should a company come under critical scrutiny. An example is
Starbucks which has been a target of anti-globalisation activists. Starbubuck’s
active involvement in CSR, however has helped to provide a defence against
its detractors. This includes paying a premium for coffee beans grown on envi-

14 Joss. P. H Tompkins, M.E and Hays, S.W (1989) In praise of difficult people: a portrait of a com-
mitted whistleblower, Public Administration Review 40 (6) pp. 552-61
15 Vasella D (2002) Temptation is all around us. Fortune 18 November pp. 132-33

414
ronmentally and socially responsible farms. Starbucks also makes donations to
local literacy organizations, regional AIDS walks and other worthwhile causes.16
The development of a CSR strategy highlights the need for companies to ac-
count to stakeholders beyond the traditional shareholder/investor grouping.
These additional stakeholders are employees, suppliers, customers, the envi-
ronment and society in general. As outlined above, the principal drivers of cre-
ative accounting include a desire to reduce taxation and to control dividends,
both of which are designed to enhance the wealth of a firm’s shareholders.
As CSR results in a broadening of corporate accountability, the interests of
shareholders are less likely to be pursued at the expense of other stakeholders.
Consequently, as companies increase their focus on CSR this may lead to a
reduction in the use of creative accounting practices.17

4.19. Environmental accounting

In recent years there has been an increasing awareness of the impact of busi-
ness on the world’s natural resources. The destruction of the rain forest and the
onset of global warming have contributed to extreme weather conditions and
left several species of animals facing extinction. The widespread flooding in
Australia in January 2011 is indicative of the fact that the world is facing serious
climate change issues that will have to be addressed urgently.
The potential for business to seriously damage our ecosystem has been made
starkly evident by the magnitude of BP’s oil spill in the Gulf of Mexico in April
2010. It is feared that oil from what is America’s second largest oil spill ( the Exx-
on Valdez 1989 spill is the largest) may have serious long-term consequences
for the entire Gulf region. It is believed that the undersea oil has posed a direct
threat to large marine wildlife such as sharks and also tiny life forms such as
shrimps, crabs and worms. By endangering the latter population which are the
foundation of the marine food chain, the oil could potentially have a chronic
long-term effect on the wider Gulf ecosystem.18

4.20. Disclosure of environmental information in the companies’

annual reports
It has become increasingly common for companies to disclose environmental
information in their annual reports. This has been motivated largely by inves-
tors’ concerns about the risk posed by environmental issues such as emission
levels and toxic waste management. Improved disclosure has also resulted
from a realization that a company’s commitment to using renewable energy
sources, rather than fossil fuels, enhances its corporate image and its long-
term business prospects.
16 Coase, Ronald (1937), The nature of the firm, Economica, 4, 386-405
17 Buckley, C Cotter D, Hutchinson, M and O’ Leary C (2010) Empirical evidence of lack of signif-
icant support for whistleblowing, Corporate Ownership Control & (3) Spring pp.275-83
18 Munzing P.G. (2003) Enron and the economics of corporate governance. Department of Eco-
nomics, Stanford University Available at http:// www.econ.stanford.edu

415
Baxter International Inc., a global healthcare company, puts environmental is-
sues at the front of its agenda by issuing a separate Sustainability Report. In
respect of its operations and products Baxter states its priorities as follows:19
1. Baxter will drive a green supply chain
2. Baxter will drive reductions in its carbon footprint
3. Baxter will drive reductions in its natural resource use
4. Enhanced product stewardship.20
In its 2009 Report Baxter committed itself to the following environmental goals
by the year 2015:
1. Reduce the carbon footprint of Baxter’s US car fleet by 20% from 2007
baseline
2. Incorporate green principles into Baxter’s purchasing programme with
its top 100 suppliers
3. Reduce greenhouse gas emissions by 45% indexed to revenue, from
2007 baseline
4. Increase energy usage of renewable power to 20% (of total)
5. Reduce total waste generation by 30% indexed to revenue from 2005
baseline
6. Eliminate 5,000 tonnes of packaging material from products sent to
customers
7. Reduce water usage by 35% indexed to revenue from 2005 baseline
8. Implement two projects to help protect vulnerable watersheds or provide
communities with enhanced access to clean water
9. Identify new opportunities to replace, reduce and refine (3Rs) the use of
animal testing.
Baxter’s commitment to environmental sustainability is to be lauded and the
disclosures in its Sustainability Report are extremely informative. There is, how-
ever a lack authoritative guidance among standard setters such as the IASB
regarding the disclosures that should be provided in respect of environmental
issues. This leaves investors unable to adequately assess a company’s expo-
sure to environmental risks, or to carry out a reliable comparison of companies
in this respect.21

19 Breton. G and Taffer R. (1995) Creative accounting and investment analyst response, Account-
ing and Business Research 25 (98) pp. 81-92
20 Daynard, R A, Bates C. and Francey, N. (2000) Tobacco litigation worldwide, British Medical
Journal, 8 January,pp. 111-13
21 Nasser K.H.M (1993) Creative financial accounting: Its nature and Use, Prentice Hall Interna-
tional (UK) Limitied

416
4.21. Accounting for environmental costs
To date, the IASB has dealt with environmental accounting issues in its main-
stream standards. For example, IAS 36 Impairment of Asset and IAS 37 Pro-
visions, Contingent Liabilities and Contingent Assets refer to environmental
issues. Other standards, such as IAS 16 Property, Plant and Equipment can
also be employed to deal with issues of an environmental nature. It is likely,
however, that the IASB will issue more specific reporting requirements for envi-
ronmental matters in the future. This is likely to result from increased legislative
requirements relating to environmental issues. For example, in the future, a com-
pany may have to obtain a certificate to verify its use of renewable energy sources.22

5. Results and discussion

Business exist to make a profit. Thus, the basic accounting concept is that:
Profit = income-expenses
However, business profitability is determined by the matching principle –match-
ing income earned with the expenses incurred in earning that income. Income is
the value of sales of goods or services produced by the business. Expenses are
all the costs incurred in buying, making or providing those goods or services and
all the marketing and selling, production, logistics, human resource, IT, financ-
ing, administration and management cost involved in operating the business.
The profit (or loss) of a business for a financial period is reported in a Profit and
Loss account. This will typically appear as in Table 3.
The turnover is the business income or sales of goods and services. The cost
of sales is either:
-- The cost of providing a service, or
-- The cost of buying goods sold by a retailer, or
-- The cost of raw materials and production costs for a product
manufacturer.
However, not all the goods bought by rather or used in production will have
been sold in the same period as the sales are made. The matching principle
requires that the business adjusts for increases or decreases in inventory – the
stock of goods bought or produced for resale but not yet sold. Therefore, the
cost of sales in the accounts is more properly described as the cost of goods
sold, not the cost of goods produced. Because the production and sale of ser-
vices are simultaneous, the cost of services produced always equals the cost
of services sold (there is no such thing as an inventory of services). The dis-
tinction between cost of sales and expenses leads to two types of profit being
reported: gross profit and operating profit.

22 Miller A.D.(2010) Book review, The British accounting Review 42 pp.132-33

417
Gross profit is the difference between the selling price and the purchase (or
production) cost of the goods or services sold. Using a simple example, a re-
tailer selling baked beans may buy each tin for 5p and sell it for 9p. The gross
profit is 4p per tin.
Gross profit = sales –cost of sales

Table 1. Profit and loss account

Expenses will include all the other (selling, administration, finance etc) cost of
the business, that is those not directly concerned with buying, making or provid-
ing goods or services, but supporting that activity. The same retailer may treat
the rent of the store, salaries of employees, distribution and computer costs and
so on as expenses in order to determine the operating profit.
Operating profit = gross profit – expenses
The operating profit is one of the most significant figures because it represents
the profit generated from the ordinary operations of the business. It is also
called net profit, profit before interest and taxes (PBIT) or earnings before inter-
est and taxes (EBIT).
The distinction between cost of sales and expenses can vary between indus-
tries and organizations. A single store may treat only the product cost as the
cost of sales and salaries and rent as expenses. A large retail chain may include
the salaries of staff and the store rental as cost of sales with expenses covering
the head office, corporate costs. For any particular business, it is important to
determine the demarcation between cost of sales and expenses.
From operating profit, a company must pay interest to is lenders, income tax to
the government and a dividend to shareholders (for their share of the profits as
they -unlike lenders - do not receive an interest rate for their investment) The
remaining profit is retained by the business as part of its capital (see Table 1 ).
Not all business transactions appear in the Profit and Loss account. The second
financial statement is the Balance Sheet. This shows the financial position of
the business – its assets, liabilities and capital – at the end of a financial period.
Some business payments are to acquire assets. Fixed assets are things that
the business owns and uses as part of its infrastructure. There are two types
of fixed assets: tangible and intangible. Tangible fixed assets comprise those
physical assets that can be seen and touched, such as buildings, machinery,

418
vehicles, computers etc. Intangible fixed assets comprise non-physical assets
such as the customer goodwill of a business or its intellectual property, e.g. its
ownership of patents and trademarks.
Current assets include money in the bank, debtors (the sales to customers on
credit, but unpaid) and inventory ( the stock of goods bought or manufactured,
but unsold). The word current in accounting means 12 months, so current as-
sets are those that will change their form during the next year.
Sometimes assets are acquired or expenses incurred without paying for them
immediately. In doing so, the business incurs liabilities. Liabilities are debts that
the business owes. Liabilities – called creditors in the balance Sheet – may be
current liabilities such as bank overdrafts, trade creditors (purchases of goods
on credit, but unpaid) and amounts due for taxes etc. As for asset, the word cur-
rent means that the liabilities will be repaid within 12 months. Current liabilities
also from part of working capital.
Long term liabilities or creditors due after more than one year cover loans to
finance the business that are repayable after 12 months and certain kinds of
provisions. Capital is a particular kind of liability, as it is the money invested
by the owners in the business. As mentioned above, capital is increased by
the retained profits of the business ( the profit after paying interest, tax and
dividends ).
The Balance Sheet will typically appear as in table 5. In the Balance Sheet,
the assets must agree with the total of liabilities and capital, because, what the
business owns is represented by what it owes to outsiders (liabilities) and to the
owners (capital) This is called the accounting equation:

Assets = liabilities + capital

or
Assets - liabilities = capital

Table 2. Profit and loss account (extended)

419
However, the capital of the business does not represent the value of the busi-
ness- it is the result of the application of a number of accounting principles.
In addition to the Financial Reporting Standards and Statements of Standard
Accounting Practice referred to earlier, there are some basic accounting prin-
ciples that are generally accepted by the accounting profession as being im-
portant in preparing accounting reports. However, an important principle that is
particularly relevant to the interpretation of accounting reports is the matching
principle.
The matching (or accruals) principle recognizes expenses when they are in-
curred (accrual accounting ) not when money is received or paid out (cash
accounting). While cash is very important in performance of a business from
year to year.

6. Conclusions
This paper has presented the regulatory environment within which financial
statements are prepared.
The International Accounting Standards Board is a key contributor to the regu-
latory process. Motivated by its desire to achieve global convergence of finan-
cial reporting practices, the IASB accepts submissions from various interested
parties as part of the process of developing international financial reporting
standards. The IASB’s conceptual framework is an important component in en-
suring that its IFRSs are based on a set of internally consistent principles.
Legislation and stock exchange rules are other key sources of financial report-
ing regulation.
Management also has a crucial role to play in determining the content of fi-
nancial statements. Positive accounting theory proposes three hypotheses to
explain how management may exercise its choice of accounting policies. Rea-
sons are also offered as to why management may elect to employ creative
accounting techniques when preparing financial statements.
The use of creative accounting practices in the corporate sector can have neg-
ative economic consequences for society. Left unchecked creative accounting
has the potential to undermine an entire economic system. This paper outlines
the reasons why companies engage in creative accounting and provides ex-
amples of techniques that have been uses in practice. It is argued that a range
of measures, when used together, present the best means of preventing the
practice and spread of creative accounting.23

23 Akerlof, G (197)) The market for lemons, quality uncertainty and the market mechanism, Quar-
terly Journal of Economics, 84, pp 488-500Akerlof, G (197)) The market for lemons, quality uncer-
tainty and the market mechanism, Quarterly Journal of Economics, 84, pp 488-500

420
Financial reporting regulation which is a key defence, includes both legislation
and the accounting standards of bodies such as the IASB. The discourage cre-
ative accounting regulatory requirements must also be enforced and monitored
with appropriate penalties being imposed for non compliance. Commitment to
a corporate governance code can also help by establishing solid organizational
structures, designed to discourage the use of creative accounting.
If creative accounting is to be eradicated however, it will also be necessary to
reshape corporate culture. An increased focus on ethics in education has a
role to play in emphasizing the importance of integrity when making business
decisions. A commitment to corporate social responsibility and to an environ-
mentally friendly company culture can also contribute by creating a culture of
good citizenship, and a realization that firms are accountable to a broad range
of stakeholders. Finally, providing a supportive environment for whistle-blowers
will ensure that when creative accounting abuses do occur, they will be ex-
posed as early as possible.

421
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423
 CHAPTER 25

Blockchain accounting:
Trailblazers’ response to a changing paradigm

Milos Milosavljevic 1, Nevenka Zarkic Joksimovic 2, Nemanja Milanovic3

ABSTRACT

Blockchain is a secure distributed ledger promising to change the principles of centu-

ries-old double entry based accounting. Practitioners worldwide have embraced this
concept and an immense funds and effort has been invested into mastering new fea-
tures of blockchains and its use in day-to-day transaction recording. On the other side,
scholars are not keeping the pace with the practice. The phenomenon of blockchain
technology has been out of the research radars by now. This paper aims to explore
the drivers of blockchain technology use in accounting. Based on the Unified Theory
of Acceptance and Use of Technology, we developed a questionnaire to examine the
tech-savvy accountants (trailblazers). In total 85 respondents indicated that the future
use of the technology will mostly depend on the performance expectancy and social
influence.

Key words: Blockchain, Blockchain Accounting, Technology Acceptance,

Trailblazer Analysis

JEL classification: M41, O33, D23

1. Introduction
A double-entry accounting has not changed its basic principles since the period of
Renaissance. This method which has assured arithmetic integrity and account-
ability for five centuries might be at its dawn (Kokina, Mancha & Pachamanova,
2017). The paradigm of double-entry accounting could be revolutionized with the
triple-entry accounting empowered by the use of blockchain technologies. Block-
chain is a distributed ledger technology that provides nearly immediate record of
transactions without the need for a third-party assurance (auditing).

1 Assistant professor, University of Belgrade, Faculty of Organizational Sciences, 154 Jove Ilica
Street, 11000 Belgrade, Serbia. Scientific affiliation: financial management, accounting. Phone:
+381 11 3950 875. E-mail: milosavljevic@fon.bg.ac.rs.
2 Professor, University of Belgrade, Faculty of Organizational Sciences, 154 Jove Ilica Street,
11000 Belgrade, Serbia. Scientific affiliation: financial management, accounting. Phone: +381 11
3950 819. E-mail: zarkic-joksimovic.nevenka@fon.bg.ac.rs.
3 Ph.D. student, University of Belgrade, Faculty of Organizational Sciences, 154 Jove Ilica Street,
11000 Belgrade, Serbia. Scientific affiliation: financial management, accounting. Phone: +381 11
3950 875. E-mail: nemanja.milanovic@fon.bg.ac.rs.

425
Ever since its introduction a decade ago, blockchain accounting has attracted
an immense attention among practitioners worldwide. Major consulting com-
panies even perceive it as an utmost game-changer in the accounting industry
(Deloitte, 2016). Although conventional wisdom assumes that accounting schol-
ars should be at the forefront of the examinations of potential uses of blockchain
technology in accounting, it seems that they have not firmly embraced the idea
of this technological revolution yet. Only a paucity of papers in high-end ac-
counting journals even mention the idea of blockchains (Kornberger, Pflueger &
Mouritsen, 2017; Sunder, 2016), let alone its possible uses. To our knowledge,
our work marks the first empirical exploration of this phenomenon.
We aim to fill the gap in the current body of knowledge by identifying the main
constructs associated with the potential use of blockchain accounting. We
based our study on the Unified Theory of Consumer Acceptance Technology
(Vankatesh, et al., 2003) and analyzed how 1) performance expectancy, 2)
effort expectancy, 3) social influence, 4) facilitating conditions affect behavio-
ral intention to use blockchain for the accounting purpose among the fintech
trailblazers.
The rest of paper proceeds as follows. In Section 2 we review the literature
related to the blockchain accounting – the meaning, possible implications to
the accounting profession and the main risks associated to its use. Section 3
elaborates on the methodology. In Section 4 we deal with the survey findings.
Continuing with the results, we place our work in context with the related work
in the field in Section 5, which is reserved for the discussion and conclusions.

2. Literature review

2.1. Blockchain accounting – a jack-in-the-box

Blockchain technology has been steadily developing in the last decade. It was
initiated in 2008 as a core component to support transaction of bitcoin - the
most widespread cryptocurrency (Zao, Fan & Yan, 2016). It the most general
sense blockchain is a distributed digital ledger with the chronological records of
transactions available to all those who have the access to view recorded data.
The information in the blockchain can be viewed but copying or altering the
data is impossible (Scull, 2017).
As for the accounting practice, “the technology is expected to affect auditing,
cybersecurity, and financial planning and analysis” (Tysiac, 2017). “The Big
Four” accounting firms are investing heavily in the technology, and they already
have several dozens of blockchain prototypes.
A myriad of reasons is indicated as a promising benefit of distributed ledgers:
• First, blockchains are powerful databases with fast communication. The
circulation of data is more efficient compared to existing software appli-
cations which ultimately improves the efficiency of transaction recording.

426
 • Second, data entry is automated with the use of smart contracts. As
such, most of the accounting entries are automated which significantly
decreases the possibility for any operational (human-based) error.
• Third, the database is distributed with each party having access to all
previous transaction. This improves the ever-needed transparency in
business reporting.
• Fourth, the transmission is based on peer-to-peer bases and communi-
cation does not require any central node (for instance bank or any other
payment system agent). This reduces the costs of transactions.
• Fifth, the records are irreversible. Once recorded, transaction can not be
altered because the blocks in the blockchain are immutable. Therefore,
any attempt of fraud is almost impossible. It would require changes on all
copies of distributed ledger at the same time to modify the record which
is only possible in theory.
• Sixth, having in mind the fact that all the transactions are digital makes
them highly programmable. This means that one can insert any compu-
tational logic to transaction and they can become fully automated.
• Seventh, they can minimize the need for or utterly change the auditing
profession. As the transactions are verified by nods, they have a “near
real-time” approval and assurance that consequent financial reports will
lack of any (or at least materially significant) errors. Some blockchains
even experiment with node-less verification of transactions (such as
IOTA) based on directed acyclic graphs, or Tangles. Nonetheless, these
algorithms have not been fully tested for the proof-of-work and they are
more promising in terms of cracking the problem of scalability.
Even though blockchain technology may revolutionize the way of recording
transactions, the path for the full application of these principles has many im-
pediments. Some flaws for a secure alternative to the extant accounting ledg-
ers have already been identified in the current body of knowledge.
In a very narrow (purely accounting-based) sense, Coyne & McMickle (2017)
emphasize that blockchains are designed for the purpose of cryptocurrencies.
They exist within the blockchain, whereas other still remain. Also, a dithyramb
on immutability of blockchain is related to the solution of the Byzantine Gener-
als’ Problem, guaranteeing consistency even if there is a potentially malicious
participant that behaves arbitrarily (Gramoli, 2017). This is a fundamental con-
tribution to the decentralization and distribution of databases, but it relies on
the presumption of the blockchain consensus – proof-of-work or proof-of-stake.
Not only that they raise general problems - wasting to much electric energy
or getting the rich even richer (Zheng, et al., 2017) – but it does not conform
inter-organizational setting and seems rather inapplicable in the business envi-
ronment. Rückeshäuser (2017) examined the possible case for the blockchain
accounting use with the malicious involvement of top management where the

427
top management has a possibility to exert the majority of computer power. Ac-
cordingly, it would be harder to circumvent internal and external control than to
execute fraudulent behavior in a blockchain setting. More generally, blockchain
technology has some additional flaws for being fully applicable in everyday trans-
action recording. One such issue is the scalability of the system and a need
for the improvement in throughput. Peters and Panayi (2015) states that ‘cur-
rent blockchain structures, requiring the repetition of computation on all network
nodes, will rapidly run into scalability issues, and this will require consideration
before mass adoption becomes possible’. However, much of it has already been
indicated as a solution to this problem (Herrera-Joancomartí, J., & Pérez-Solà,
2016). Other issues are related to smart contracts - self-executing scripts that re-
side on the blockchain – which have hitherto been fairly simple and inconvenient
for accounting and wider business purposes (Christidis & Devetsikiotis, 2016).
The blockchain for the accounting purpose is still at its infancy. However, as for
the other foundational technologies, it will pave its way to the broad use. In a
recent IBM study, the first-movers have already embraced commercial applica-
tion of blockchain technologies (Figure 1).

Figure 1. Commercial adoption of blockchain

Source: IBM (2016)

2.2. Theoretical background and the research model

For the purpose of building the theoretical model on the use of blockchain ac-
counting, we adopted the Unified Theory of Acceptance and Use of Technology
developed by Vakatesh et al. (2003). The model has been widely used for all
emerging technologies, such as the use of social media (Curtis et al., 2010),
the use of newly implemented Enterprise Resource Planning systems (Sykes
& Vakatesh, 2017), 3G technology in mobile communications (Xu, Thong &
Tam, 2017).

428
The theory posits that 1) performance expectancy, 2) effort expectancy, and
3) social influence are the main determinants of user behavior, and indirectly
affect the potential use of certain technology, whereas the facilitating conditions
directly affect the use of technology.
By analogy, this should be a proper model for the examination of blockchain
technology usage in accounting. Nevertheless, the use of blockchain account-
ing is a complex phenomenon. As inferred by Byström (2016), “in accounting,
blockchains could potentially improve the quality of information reaching in-
vestors in two ways; by making the accounting information more trustworthy
and by making the information more timely”. This is broad and hard-to-operate
definition. More precise adoption of this technology is elaborated in Iansiti and
Lakhani (2017). They state that the use is still in the early phase (single use). As
the technology further develops, it will substitute current practices in accounting
or be locally used. However, the peak is reached in the transformation quadrant
illustrated in Figure 2.

Figure 2. The adoption of blockchain

Source: Adopted from Iansiti and Lakhani (2017)

429
Following the main determinants and the main aspects of blockchain usage in
accounting, we constructed the set of hypotheses illustrated in the theoretical
model (Figure 3).

Figure 3. Theoretical model

3. Methodology
3.1. Research variables and measures
We based our study on primary data and employed a questionnaire as a re-
search tool. The questionnaire had four sections. The first section dealt with the
demographics of examinees.
The second section encompassed all the constructs of blockchain usage de-
terminants rewarded from Vakatesh et al. (2003), which included performance
expectancy, effort expectancy, social influence, facilitating conditions and user
behavior. The third section included the stages of the blockchain use following
the recommendations of Iansiti and Lakhani (2017). All the survey items are
presented in the Appendix 1.
To ensure the construct validity, relevant constructs from other studies were
adapted. After the questionnaire was pretested by 6 faculty members from
the Faculty of Organizational Sciences in Belgrade, some items were slight-
ly modified to best fit the context of the study. All the items were measured
on a Likert-type scale (responds were coded from 1 – strongly disagree,
to 5 – strongly agree).

430
3.2. Sampling procedure
The questionnaire was distributed to trailblazers using a paper-and-pencil ap-
proach. Trailblazers or ‘first movers’ were interviewed at two fintech confer-
ences. To consider some examinee to be a trailblazer, one had to fit following
two criteria:
• A minimum of 5 years of experience in accounting,
• A minimum visit to one conference on financial technologies.
As the total population of such a cohort is unknown (to the best of our knowl-
edge there is no global database of tech-loving accountants), we based the
study on a “snowball” sampling technique (Biernacki and Waldorf, 1981). This
sampling relies on peer-to-peer recruitment of study participants and formation
of a referral chain (Bodin et al., 2016). Although it can be a subject of various
biases (see Avrachenkov, Neglia and Tuholukova, 2016), the referral chain was
actively controlled – particularly its initiation, progress and termination. Using
the coded questionnaires, the number of referrals was controlled to limit the
clustering within organizations.

3.3. Data collection and analysis

Data was collected in the period January-February 2017 by a group of trained
assistants. Afterwards, the data was entered in SPSS (Statistical Package for
Social Sciences). Quantitative data was analyzed with descriptive statistics:
percentages, means and standard deviations. Interdependence of determi-
nants (independent variables) and contract management efficiency (dependent
variable) was determined by correlation (Pearson moments two tailed correla-
tion coefficient analysis) and multiple regression.

4. Empirical data (documentation background) and analysis

4.1. Sample description
The study was conducted among the accountants and business analysts that
attended fintech conferences (which was used as a proof of their ‘trailblazer’
status). In total 28 examinees filled the questionnaire at the conferences. They
were also used to create a referral chain which led to a total of 85 respondents.
Regarding their gender status, the sample was relatively balanced (58.82%
were women). Most of them worked in large companies (33.7%) and medium
sized companies (28.9%). Examinees were well balanced in terms of the indus-
try background (Information and communication – 16.5%, trade and commerce
– 15.3%, consulting – 10.6% and other services14.1% had more than 10%
representation in the sample).

431
4.2. Pre-analysis
Before we tested the hypotheses of the study, we conducted a pre-analysis
of data. For these purposes we analyzed descriptives – means and standard
deviations, and correlation analysis. The data is shown in Table 1.

Mean StD 1 2 3 4 5 6
Performance Expectancy 3.00 .94 1 .136 .459 -.053 -.007 .580
Effort Expectancy 3.30 .56 1 .096 .141 .142 .059
Social Influence 3.73 1.08 1 .390 .415 .484
Facilitating Conditions 3.86 .86 1 .961 .181
Behavioral Intentions 3.93 .86 1 .249
Use of blockchain 2.91 1.10 *
1

Table 1. Descriptive statistics and correlation matrix for research variables

bold – significant at 0.05; Cronbach‘s Alpha for the use of blockchain= .823
Source: authors’ calculation

All the measures were composite. The first five of them were rewarded from
other studies and tested for internal consistency. The last one - Use of block-
chain – was developed for the purpose of this study and computed as an arith-
metic mean of four possible uses of blockchain in accounting. Accordingly,
we conducted the internal consistency test and calculated Cronbach’s Alpha
(.823). Using the rule of thumb for this indicator we concluded that internal con-
sistency could be marked as good (.9>α≥.8)
As displayed in Table 1, we identified a strong positive relation between a num-
ber of variables. The highest correlation coefficients were calculated for Perfor-
mance Expectancy (r=.580, p<.01) and Social Influence (r=.484, p<.01). Also,
significant correlation was found for Behavioral Intentions.

4.3. Main analysis

Since the study found a number of significant positive correlations, the next
step was the examination of the influence and intensity of variables seen as in-
dependent to Behavioral Intentions (dependent variable) in the first model. The
results of the regression analysis indicated that the research model predicted
25% (R2=.25) of the variance which is displayed in Table 2. As Durbin-Watson
was d=1.719 (between two critical values 1.5<d<2.5), it could be assumed that
there is no first order linear autocorrelation in the multiple linear regression
data. Multicollinearity was further examined with the variance inflation factor,
and we have not found high values for VIF.

432
 Variable Coefficient Std Error t-statistic Prob
Constant 2.543 .600 4.239 .000
Performance Expectancy -.261 .106 -2.470 .016
Effort Expectancy .195 .160 1.217 .228
Social Influence .414 .091 4.533 .000
R square .250 F 7.657
Adj R square .217 Sig .000
SE of regression .759 Dependent variable: Behavioral Intentions

Table 2. Regression model for behavioral intentions as a dependent variable

Source: authors’ calculation

As indicated in Table 2, the study confirmed hypotheses H1 and H3, but the
hypotheses H2 lacks of empirical validation.
In the second model, we tested the intensity of the relationship between Be-
havioral Intentions and Facilitating Conditions, on one side, and the Use of
blockchain, as a dependent variable on the other. The results are displayed in
Table 3.

Variable Coefficient Std Error t-statistic Prob

Constant 1.643 .631 2.604 .011
Behavioral Intentions 1.140 .506 2.252 .027
Facilitating Conditions -.841 .509 -1.653 .103
R square .097 F 3.846
Adj R square .071 Sig .026
SE of regression 1.051 Dependent variable: Use of blockchain

Table 3. Regression model for the use of blockchain as a dependent variable

Source: authors’ calculation

As the Durbin-Watson was 1.493, we checked for multicollinearity in the data.

We found strong multicollinearity between Facilitating Conditions and the Use
of Blockhain. Accordingly, we excluded Facilitating Conditions as a predictor of
the dependent variable. In the nutshell, the study confirmed hypothesis 4, but
hypothesis H5 is unverified.

5. Results and discussion

5.1. Key findings, contributions and implications
The aim of this paper was to identify the main constructs associated with the
potential use of blockchain for accounting purposes. Based on the Unified The-
ory of Acceptance and Use of Technology, we developed a theoretical model
for the future acceptance and use of blockchain accounting. We analyzed the

433
responses of 85 ‘first movers’ in accounting and financial technologies (fintech).
Following the results presented in the previous section, we constructed the
verified model, which is illustrated in Figure 4.

Figure 4. Verified model

The main drivers for the behavioral intentions in the use of blockchain as a
cutting-edge technology in accounting are performance expectancy and so-
cial influence. As for the performance expectancy, the extant literature provides
several explanations. Watson (2017) states that ‘accountants often struggle to
manage and understand the data of the ever-growing volume of transactions,
prepare trial balances and financial reports, and analyze results in a timely
manner’. Blockchain can improve the efficiency by enabling the automation of
reporting with ever-growing data. Moreover, there are promises that blockchain
will foster a real-time, verifiable, and transparent accounting ecosystem (Dai
and Vasarhelyi, 2017).
With regards to the social influence and its relation to the behavior intentions,
it seems that the buzz created around blockchains is paving the way for the
future use of this technology in everyday accounting operations. Some authors
even address it as a fintech tsunami and the driver of the Fourth Industrial Rev-
olution (Chuen & Lee, 2017). However, most of this show-off for the blockchain
technology is affected by cryptocurrencies, rather than the true applicability at
the moment.
The main implications of this study are twofold. First, this paper marks the first
empirical testing of the drivers of blockchain use in accounting. We adapted
and refined the constructs used for the measurement scales for these specif-
ic purposes. Also, we added some empirical evidence on the possible future
use of blockchain in accounting to very humble academic body of knowledge.
Second, this paper has implications for practitioners. As a technology still at its
infancy, they can benefit from the analysis of the main drivers of its use in years
to come. The crucial thing that technology developers should focus on is the
performance for the accounting ecosystem.

434
5.2. Limitations and further recommendations
The main flaw of this study is the size of the sample. This raises the question
of the generalizability (and consequently external validity) of the study findings.
Even though the study is funded on a fundamental technology acceptance the-
ory, the findings should be considered as an attempt to provide an early over-
view, rather than be conceived as an utter addition to the theory. Nevertheless,
this is an opportunity for future research. By using the same methodology and
sampling outside the ‘first movers’ in accounting technology, they would im-
prove the validity of this findings.
The study examined the technology not yet firmly incorporated and rooted in
everyday accounting operations. The respondents based their answers on the
potential, rather than real benefits of the technology. Although the technology
is not far away from blueprinting new economy (Swan, 2015) and changing the
way we account transactions, the use is still in a very early stage. This creates
an avenue for further research. The main fields of explorations should be cen-
tered around the real cases of blockchain application to accounting systems of
different organizations.
This study is cross-sectoral and captures only a static dimension of the drivers
oh blockchain use. The blockchain technology is developing at an amazing
pace (Nguyen, 2016). For more prolific results, a new study with the time-series
analysis would be needed. Only then would the evolutionary characteristics of
the research phenomena be captured.

6. Conclusions
This paper discusses how blockchain technology can revolutionize the ac-
counting profession. Having in mind that these changes will materialize in the
following years, we examined readiness of tech-savvy accountants to adopt
new technology. Moreover, we empirically confirmed that the main drivers for
the behavioral intention to use technology are expected performance and so-
cial influence. Accounting professionals have had small-scale (r)evolutions re-
lated to the implementation of spreadsheets or use of computers for day-to-day
operations, but this novel technology is expected to change the landscape of
accounting profession as we know it. Still, this statement is in a rather clair-
voyant-fashion. As a centuries-old discipline, accounting should seek for the
real proof-of-work for the blockchain technology and stick to the principles of
professional skepticism.

435
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Appendix 1 Survey items

Performance expectancy (PE)

PE1. I find blockchain transactions to be useful in my daily life.
PE2. Using blockchain transactions will increase my chances of achieving
things that are important to me.
PE3. Using blockchain transactions will help me accomplish things more quickly.
PE4. Using blockchain transactions will increase my productivity.

Effort expectancy (EE)

EE1. Learning how to use blockchain transactions is easy for me.
EE2. My interaction with blockchain transactions is clear and understandable.
EE3. I find blockchain transactions to be easy to use.
EE4. It is easy for me to become skillful at using blockchain transactions.

Social influence (SI)

SI1. People who are important to me think that I should use blockchain
transactions.
SI2. People who influence my behavior think that I should use blockchain
transactions.
SI3. People whose opinions that I value prefer that I use blockchain
transactions.

Facilitating Conditions (FC)

FC1. I have the resources necessary to use blockchain transactions.
FC2. I have the knowledge necessary to use blockchain transactions.
FC3. Blockchain transactions is compatible with other technologies I use.
FC4. I can get help from others when I have difficulties using blockchain
transactions.

Behavioral intentions (BI)

BI1. I intend to use blockchain transactions in the future.
BI2. I will try to use blockchain transactions in my daily life.
BI3. I plan to use blockchain transactions frequently.

Use
Please choose your usage frequency for each of the following (frequency
ranged from “never” to “many times per day”):
a) Retailer gift cards based on bitcoin.
b) Self-executing smart contracts.
c) Bitcoin payments.
d) Private online ledgers for processing financial transaction

439
 PART 7

INNOVATION ECONOMICS / BIG DATA IN BUSINESS

AND ECONOMICS
 CHAPTER 26

What determines an optimal moment of accession to the EU?

Evidence from later enlargements

Srđan Marinković1, Zenaida Šabotić2, Dragić Banković3

ABSTRACT

The formation of the European Union (EU) was a very demanding and hard work, but
its preservation seems to be even harder. Despite all the difficulties that had been ex-
posed during development, EU managed to preserve the core values on which it was
based. Many countries are trying to harmonize national economic policy with economic
policy of EU and became the members of the same. However, for the future and stabil-
ity of the EU and all member countries, it is important to assess when is the best time
for new enlargement. In this paper, we have tested a number of macroeconomic and
macro-financial variables in order to test whether a number of countries were ready to
join the EU, as well as, when the candidates will be ready to do so. Some variables
present criteria of nominal convergence, as defined in Maastricht Treaty, while the rest
of variables indicate the level of real convergence. Univariate analysis has indicated that
the membership in the EU is significantly affected by the current account balance (% of
GDP), GDP per capita, final consumption expenditure, the gross national expenditure
and inflation. Following the univariate binary logistic analysis and separation of varia-
bles that affect the individual membership in the EU, a multivariate regression analysis
was applied, including in the model some previously excluded variables. Multivariate
binary logistic regression confirmed significance of final consumption and consumption
expenditure, while Gross capital formation has had only indicative effect on membership
in the EU. The analysis indicated the importance of selecting the timing of accession in
terms of the achieved economic development, expressed through the selected macro-
economic indicators.

Key words: macroeconomic indicators, European Union, monetary

integration, convergence criteria

JEL classification: F15, F16, F45

1 Professor, University of Niš, Faculty of economics, Trg kralja Aleksandra Ujedinitelja 11, 18000
Niš, Serbia. Phone: +38162216068. E-mail: srdjan.marinkovic@eknfak.ni.ac.rs.
2 Teaching Assistant, State University of Novi Pazar, Department of Economic Sciences, Vuka
Karadžića bb, 36300 Novi Pazar, Serbia. Phone: +38120337669. E-mail: zenaida.sabotic@gmail.com
3 Professor, State University of Novi Pazar, Department of Mathematical Sciences, Vuka Karadžića
bb, 36300 Novi Pazar, Serbia. Phone: +38120337669. E-mail: dragic.bankovic@gmail.com.

443
1. Introduction
The first step for candidate countries to join the European Union (EU) is de-
manded by several criteria of which only one is clearly economic in its na-
ture. Namely, perspective new members should prove their ability to sustain
competitive pressures within the EU in the systemic framework that would not
give protection that goes beyond the institutions acceptable for a fully-fledged
market economy. The other two elements concern political criteria (stable insti-
tutions that guarantee democracy, rule of low, human rights, and the protection
of minorities), and adherence to the aims of political, economic and monetary
union (adopting acquis communautaire, the complete framework of the EU leg-
islation). Interestingly, even the last line of Copenhagen criteria for accession
contains institutional elements that demand from candidates to have already
remarkable achievements in terms of liberalisation, monetary and fiscal dis-
cipline. Just to mention, acquis communautaire includes free capital account
(capital flows should be restriction-free not only within the EU but also vis-à-vis
third countries), central bank independence, and no monetary support of gov-
ernment finances. Therefore, for accession countries it is strongly advisable to
use pre-preparatory phase to accomplish their transition or advance economic
development before the very entry into the EU.
In this paper, we have tested a number of macroeconomic and macro-financial
variables in order to check whether some countries were ready to join the EU,
as well as, when the candidates will be ready to do so. The analysis includes
40 countries, 28 EU members (the analysis includes Great Britain, because the
data cover the period 2000-2014) and 12 countries that were not members.
Some variables present criteria of nominal convergence, as defined in Maas-
tricht Treaty, while the rest of variables indicate the level of real convergence.
We know from the very persuasive “gravity model” of international trade that
trade between a pair of countries is proportional to their economic strength
(“mass”) and inversely proportional to the distance between them (alike to force
of gravity in Newtonian physics). Knowing that bilateral trade is a function of
national income, the same as it may explain the way that Foreign Direct Invest-
ment (FDI) and other forms of capital and labour move within the integrated
area, we expect that Gross Domestic Product (GDP) figures play a big role in
explaining perspective gains from an integration. Our empirical findings are
strong in favour of importance of GDP figures. Namely, GDP is one of the best
fitted synthetic indicators of economic strength, able to capture many dimen-
sions of prosperity and development of nations.
The rest of the paper is structured as follows: in the first section, we give some
remarks on the contemporary theory’s stance in matters of economics of re-
gional integration. The second section is devoted to empirical literature on var-
ious effects that fully-fledged integration of goods, services, capital and labour
markets may have on countries that merges into common market. Third sec-
tion gives economic rationale for the chosen data set, by reviewing the matter

444
of nominal and real convergence between units that integrate. Section four
explains data set and employed research methodology, while section five dis-
cusses the main findings. Consequently, the last section concludes.

2. Economics of regional integration – Theoretical remarks

Strictly theoretically, economic or welfare gains from forming a regional inte-
gration can be divided into three lines: allocation, accumulation and location
(Baldwin and Venables, 1995). Allocation effects are static in its nature and
assume perfect competition. Factor endowments are considered unchanged.
A decrease or a complete removal of trade barriers (trade costs) within the in-
tegrated area makes the trade between members less costly, boosts the trade
and output within the area. The positive net welfare coming from this increase is
attributable to trade creation effect. However, since this effect is initiated by dis-
criminatory trade liberalisation it may also harm interest of outside countries, as
well as inside countries. Trade diversion comes as a consequence of removal
or tariffs decreasing in trade between two regions which favours trade between
those regions on the expense of third region lowest-cost supplier which is now
prohibited by existing tariffs. The effects of trade diversion on the integrated
import countries’ welfare may be ultimately negative. Besides negative effects
borne by importing country, trade diversion also damages global allocation of
resources since it moves allocation of production away from one directed by
comparative advantage principle. Note that trade creation benefits depend on
the assumption that resources are fully employed. If this holds, the lower cost
imports will replace inefficient domestic production in domestic consumption
and consumer gains will exceed production loses (plus government tariff rev-
enue loss). However, if less efficient imports from the member country replace
the more efficient (cheaper) import from rest of the world, domestic prices will
not converge to the world prices, and overall welfare effect will be negative.
According to a theory (Matthews, 2003, p. 18), net effects of trade creation and
trade diversion, which fully reflect allocation type of welfare outcome of trade in-
tegration, should be positive if the integration takes place between comparably
developed economies, with complementary (rather than competitive) economic
structures, and economies that already reached high level of mutual trade.
Accumulation, or dynamic, effects demand different assumption about the na-
ture of competition. If the competition was imperfect because of pre-existing
trade barriers, lifting the barriers will bring new opportunities but also new chal-
lenges on producers. An access to a larger (common) market allows producers
to take advantage of economies of scale, to undergo specialisation of produc-
tion and motivates them to reduce costs of production and increase quality of
products in order to endure increased competition. From the side of consumers,
also the variety effect is important, i.e. availability of large varieties of the same
industry products, which is easier to trade within the integrated trade area.

445
Location effects are especially important if two regions, that are significantly
different in economic size and strength, are merged. Those effects are more
likely for more advance integrations that imply also free movement of produc-
tion factors (labour, capital etc.) beside free movement of goods and services.
Though one can expect that capital moves toward the areas where the capital
is scarce and labour is cheaper, it is also possible that labour migrates toward
the places where the capital is abundant and jobs are available at higher wag-
es. It may in fact amplify differences in markets size, since producers tend to
locate production capacities close to large markets, while at the same time, the
decision to locate production there in turn increases market size, by increasing
demand for intermediate and final products, the regularity known as circular
causality (Baldwin, 1997). Then, there is a chance that all mobile factors will ag-
glomerate or concentrate around a few central locations. Because of potential
location effects, a regional integration becomes a sensitive political question.
If at the end of the day, a periphery may become even more distant from the
core in terms of economic development then the overall welfare implications of
regional integration for less developed peripheral countries are questionable.
The EU presents the most completed type of regional integration. Besides re-
moval of tariffs (as well as non-tariff barriers) for trade between members (free
trade union), and unified trade and tariffs’ policy for rest of the world (custom
union) it allows free movement of economic factors along with free movement
of goods and services (well-known four freedoms), so it belongs to “common
market type” of regional integration agreements.
Calculating costs and benefits of an integration process is all but easy process.
Fortunately, at least identification of types of costs and benefits may be com-
pleted since the economic theory has some answers on it. According to the
theory of regional economic integration (Baldwin and Venables, 1995), there
are to be several benefits of the integration: i) savings on costs related to trade,
e.g. tariffs; ii) beneficial effects of forming single (larger) market that will bring
more competition and improved efficiency, and iii) easier movement of factors
of production, like foreign direct investments and labour in opposite direction.
If integration is followed by institutional financial support of incumbent to new
member countries, as it is the case with the EU, the budgetary transfers should
also be taken into account. Off course, those transfers are distributional and do
not change the position of the whole. An assessment of benefits of new mem-
ber states that would come from financial transfer demands a careful scenario
analysis. Making inferences and drawing conclusions simply based on recent
history of enlargements (other countries’ experience) may be misleading. Since
transfers are benefits of new member states and adequate costs that are to be
borne by old member states, old member states that are in charge for mak-
ing (revising) rules can act on accommodative way (Kandogan, 2000; Csaba,
2001). It is exactly what happened with the Treaty of Nice (Heinemann, 2002).
Hopefully, economic gains that are expected to come from new enlargements
are well above direct transfers from the EU budget. The highest on the list are

446
benefits of a larger (single) market free of tariffs that could boost trade within
the EU. Moreover, some benefits are expected from capital movements and la-
bour migration, together with budgetary transfer that would go from incumbent
countries toward new members.

3. Empirical evidence on costs and benefits of integration

There are variety of models and calculations used for assessing economic ef-
fects of such a unification project. The main challenge is to cover all possible ef-
fects and to express net effect using a single measure. Most often researchers
use GDP trajectories to measure effects, but there are other equally compre-
hensive approaches. For example, Kohler (2004) used welfare effects instead
GDP figures, and made assessment for each country separately, starting from
the assumption that a common enlargement shock may have different effects
on both incumbent and new member states, depending on their specific eco-
nomic structure. This justifies looking at enlargement as it is an exogenous
shock that would lead to asymmetric disturbances across the EU. According to
a comprehensive ex ante assessment (Breuss, 2002) of effects that so called
fifth enlargements may have on existing and new member states, a group of
new member states was expected to gain around ten times more from the
enlargement than the incumbent countries. It was estimated that distribution
of gains will be directed according to the size of economies and strength of
economic ties. It is also stressed that the absorption/merging of such an inho-
mogeneous group of countries brings some risks, i.e. it may postpone business
cycle synchronisation across the EU.

3.1. Trade consequences

Trade consequences of a regional integration are not easy to catch fully and
reliably. Firstly, there has to be already discussed conventional effects from
trade creation vs. trade diversion. Secondly, the trade effect of unification de-
pends on business cycles synchronisation. If economic activity moves in the
direction opposite to that of main trade partners, current account imbalance
might have a depressive effect on trade flows (Maurel, 2004). Trade intensity
between countries (or regions) has direct influence on their business cycles
synchronicity, which is per se a factor that justifies regional integration. How-
ever, though the influence must be there, the nature of this influence seems a
case specific. More trade between countries (regions) may lead either to less
synchronised business cycles, in case of specialisation of countries exporters
motivated to take advantage of comparative advantage, or exactly opposite,
more synchronised, if the business shocks are monetary or trade is largely
intra-industry type. Moreover, historically, the impact has been more like the
letter one (Rose, 2000). Finally, it seems that other aspects of integration, e.g.
monetary integration, may also exert some effects on trade. More advanced
type of regional integration that includes also integrated monetary affairs may

447
account on some extra benefits in trades within the integrated area. However,
evidence is mixed. In a seminal paper, Rose (2000) proved empirically that
trade between countries that share the same currency tend to be several times
higher that between countries that retain separate legal tenders. The result
was robust even after controlling the effect of exchange rate volatility on trade.
It may mean that a common currency area is a way more effective solution that
currency peg policy option. The author contemplates that a part of this effect
comes because an adapting of common currency is far more “serious and du-
rable commitment than a fixed rate” (Rose, 2000, p. 9). A common currency
prevents beggar-thy-neighbour policy of competitive devaluation that poten-
tially may destroy the achieved trade integration. Casual empiricism supports
above argumentation. We would say that the recent Greek shock on the EMU
showed that the exit from the monetary union is extremely complicated, both
economically and politically. Moreover, well-evidenced “home bias”, i.e. strong
propensity to trade within the country (currency area) relative to trade out of the
country, can be at least partly explained by the common currency effect.
Empirical evidence on above effects is as mixed as the prognostics based on
the international trade theory. For example, Nahius (2004) simulation based on
the gravity model of foreign trade gave estimate of two digit increase of internal
EU market, mostly based on reduction of tariffs and non-tariff barriers. The
countries that are assessed to take most benefits in that manner were Aus-
tria, Germany and Greece. The model also indicates that accession countries
will likely gain more benefits than old member states. The trade increase is
also concentrated around agriculture and some industries. Curran and Zigna-
no’s (2012) research, based on extensive data set on volume and structures
of trade, not only supports the hypothesis that formal integration of two regions
will bring more intense trade between the regions, but also reveals the fact that
countries of fifth enlargement significantly increased their mutual trade with-
out breaking the trade relationships with outside countries. However, not all
empirical studies justify optimism. For instance, Maurel (2004) questioned any
trade creation effect in case of some earlier enlargements, e.g. when Austria,
Sweden and Finland entered the EU. Similarly, running the same estimation
procedure as in Rose (2000), the author found weak effect of currency union
on trade increase.

3.2. Factor movements: FDI, capital and labour

According to neoclassical growth model, providing that capital is mobile, i.e.
no restriction is applied to cross-country movements, the capital is expected
to flow out of capital abundant more developed economies into capital-scarce
countries. The driving force is the law of diminishing returns that implies that
marginal productivity of capital in the latter economies exceeds the same in
the former economies (Buch, 1999, p. 635). This process will eventually lead
to equalisation of marginal return and increase of welfare in both capital ex-
porting and capital receiving countries. In that analytical framework, regional

448
integration is seen as a case of capital flow liberalisation. In a dynamic gener-
al equilibrium model based on neoclassical intellectual tradition, Garmel et al.
(2008) found the welfare effects of increasing capital flows between incumbent
and new members rather large, persistent and mostly attributable to the mod-
el-specific elimination of costs related to managing and monitoring cross-bor-
der investments (therefore original term “border-costs”). Although, in this study,
effects are defined in monetary terms, as cost reduction or elimination, merely
for the sake of elegance of the model, there are many benefits or conveni-
ences that go with doing business in the same legal and regulatory environ-
ment, above all, access to large market, and externally supported devotion to
politically stable and progressive market economy. If we add factor endowment
(skilled labour etc.) and available structural funds, it is then clear that new EU
member states are likely to draw capital for their investments more easily both
from the EU and the rest of the world than a non-EU country, ceteris paribus. It
was the fact in previous EU enlargements that many accession countries have
taken steps toward capital market integration years before their actual year
of EU entry. Thus, a rational market player may foresee successful enlarge-
ments and behave anticipatory. This is why effects of integration would develop
gradually, over a period of time, with some appearing already at first sign that
membership is granted (anticipatory) and some even after the formal accession
(prolonged or ex post effects).
However, the evidence provided by Buch (1999) does not suggest that EU
membership has had a significant impact on the accession countries to draw on
foreign savings. The author assessed how close the dynamics of savings is to
that of investments, running the procedure for a group of old members (South
European countries) and new entrants. It appeared unlikely that membership
alone may be attributed to capital account openness, but at the same time, it
seems that the membership may influence the structure of capital flows. Buch
and Piazolo (2001) have shown that not only capital-oriented measures, e.g. in-
ternational bank claims, portfolio investments and FDI, but also trade develop-
ments, share a number of common determinants. Regarding all different types
of capital inflow, as well as trade, GDP per capita (taken to be a proxy of host
economy’s state of development and market size) appears to be significant
variable. Thus, the benefits that a country may expect from the launching a pro-
cess of regional integration, as well as the membership effect itself, regarding
the increase in trade and different types of capital inflow depends on the level
of its market size and the state of development of the host economy, inter alia.
The empirical research also gives some clue about the origin of those benefits.
Buch and Piazolo (2001) found the integration beneficial especially for foreign
direct investments, since it reduces uncertainty about perspective business
conditions. Therefore, it appears that a sort of “credibility effects” explains at
least a part of positive effects that the integration may have on both trade and
capital (FDI) dynamics.
Further on, it comes that not only FDI is responsive to the increase of “credibili-
ty” but also capital markets. Dvořák and Podpiera (2006) tested so called entry

449
announcement effect on the stock markets of accession countries and found
that a large percent of a dramatic rise in local stock prices can be attributed to
re-pricing systemic risk. Therefore, integration effects can be rather significant
in terms of its impact on temporary revaluation of local financial assets.
By applying the same economic logic, one would expect that regional integra-
tion bring equalisation of factor prices, and that it might also hold for labour. The
region with abundant labour (higher level of unemployment, lower unit labour
costs) will take position of a labour sending region and the region with abundant
capital (labour deficient one) will be receiving labour, providing that trade liber-
alisation have not already removed incentives for such labour migrations. Such
a labour movement across the regions will contribute to income and wages
convergence. It does not have to happen if industry is imperfectly competitive,
and if there are described location effects, which are empirically proven (Crozet
and Koenig Soubeyran, 2004). Industry agglomeration will do exactly the oppo-
site, that is, the divergence of wages between the regions.
At the same time, unit labour costs, or wages, represent a decisive factor of
paramount importance in shaping attractiveness of a country for inward FDI,
and competitiveness in the common market (Belke and Hebler, 2000). Thus,
if FDI moves from one to another region, based on differences in unit labour
costs, it will diminish incentives for labour to move in the opposite direction.
However, in reality both movements will probably take place at the same time.
Some previous estimates (Breuss, 2002; Kohler, 2004) were prone to assign
welfare losses to accession countries based on anticipated labour migrations
from Central and Eastern to Western Europe. Joining the EU for countries that
entered fifth enlargement, meant migration of labour with some effects on wage
level, especially for more mobile young working population. According to some
recent studies (Elsner, 2013), lifting restriction on labour migration within the
EU contributed to new wave of emigration that accounts for six to nine percent
decrease of workforce in Latvia, Lithuania, Poland and Slovakia. Consequent-
ly, the movement of labour contributed to wage increase among most mobile
young population in home countries.
Last but not least, regional integration may be also seen as a productivity shock
with potential effects on efficiency. It is not an issue frequently studied as trade
and productive factors developments, but there is some research. Halkos and
Tzeremes (2009) by using DEA window analysis found the countries of Eastern
Europe increase their economic efficiency relative to the old Europe in the peri-
od that surrounds their EU entry, although the outcomes were far from homoge-
nous for both group of countries. The countries that compete more directly with
new entrants (labour-intensive production, FDI dependent growth etc.) were
particularly limited in efficiency growth.
From the discussion above, it comes that a country will be ready for EU entry
if it succeeds to strengthen their political and economic relationships with the
EU, and adapt the same institutional framework, already in the pre-accession

450
period. The same holds if we consider benefits that an accession country may
have from the integration. However, since accession preparation takes some
time, and there may be also hold-up tendencies, in the meantime the private
sector of accession country anticipatory invest in EU-related investments, what
increases economic dependence from the EU, and leaves the country with
costly option to abandon negotiations.
At the end of this part, before we turn to discuss the Western Balkans specificity,
we would underline very insightful conclusions drawn from the model of Wallner
(2003). The author concludes that applicants’ costs of joining the EU change
the welfare effect of membership, so that it can be eventually negative. As for
the costs of joining the EU, the author lists a number of examples, ranging from
large costs of compliance with environmental regulation to investments in EU
safety and technical standards that are costly and make accession countries’
products uncompetitive in alternative (lower-income) markets. There is a num-
ber of less visible irreversible costs related to trade specialisation, breaking up
economic relationship with previous trade partners, premature privatisation of
un-restructured domestic industries that allow EU investors to acquire the con-
trol of valuable assets at bargain prices.
If the EU acts strategically and on selfish way, it will take advantage of the
weaker bargaining position of the applicants and try to extract a rent by impos-
ing entry requirements that will ensure benefits for the EU on the expense of
the applicants. Commenting “all public declarations of common interests and
charitable EU motivations”, author said: “it is somewhat of a mystery how one
can aggregate 15 selfish countries and arrive at an altruistic total”.
This formally modelled behaviour seems more likely in future enlargements
than it was in previous ones. Previous enlargements left Europe with new in-
struments that can be effectively used in order to postpone new enlargements.
There is also stronger pressure for controlling costs that are to be borne by
incumbent states. As far as the Western Balkans is concerned, things are look-
ing in some ways the same, but in some important ways different. Among sim-
ilarities, their transitional past and (near) future is highest on the list. Moreover,
as we have seen, that distribution of enlargement benefits among old member
states depends largely upon strength of existing economic ties between each
incumbent and perspective member state. For Western Balkans countries, Ger-
many and Austria are the most important trade and investment partners, with
Italy and Greece holding a way better position than in previous enlargements
(Vachudova, 2014, p. 127). Finally, relative to the size of the EU, Western Bal-
kans countries are almost irrelevant economies. Although, it is true that even
the fifth most massive round of enlargement brought into the EU economies of
rather incomparable size, overall importance of those two groups of countries
is significantly different.
The most prominent difference between earlier and future enlargements are the
benefits that in the latter case will come well above and beyond economic gains.

451
Western Balkans is in desperate need for speeding up democratisation pro-
cess and settling down regional disputes (Elbasani, 2008; Vachudova, 2014).
Because of this specificity, for Western Balkans the EU is probably still one-way
path to stability and prosperity. But there are also new challenges that may
change the outcome of the whole project (Panagiotou, 2013). One should wait
and see how future enlargements will fit into new cracks of Europe, id est North-
South, and core-periphery collisions.

4. Nominal and real convergence as alternative ways to assess

preparedness to unification
Theoretically, based on predictive power of (neo)classical (growth) model of
diminishing returns, regional integration is expected to ensure growth conver-
gence, since it enhances factor movements that will eventually come to equal-
isation of factors’ productivity and rewards, namely relative factor prices, i.e.
wages and profit will come into alignment (Barro and Sala-I-Martin, 1991).
Scientific evidence on preparedness of countries to join the European Mone-
tary Union (EMU) is by no means scarce. A thorough review of earlier studies
one can find in Koukoritakis and Michelis (2006), while more recent evidence
is provided also in Marelli and Signorelli (2010), Bongardt and Torres, (2013)
and Dauderstädt (2014), with novel research being more pessimistic then early
assessments. It is expected that convergence issue draws more attention in
cases of monetary integration since Maastricht criteria of nominal convergence
are put as a formal barrier only to the more advance step into the EMU. Howev-
er, it would be wrong to neglect importance of the convergence, especially real
convergence even if the EMU is considered short-term option for accession
countries. Namely, if an accession country fails to converge with the rest of the
Union, it will question long-term sustainability of the integration project. For ex-
ample, Koukoritakis and Michelis (2006) tested whether ten Eastern European
and Mediterranean countries from fifth enlargement were ready to join the Eu-
rozone based on a set of nominal and real convergence criteria. Their choice of
indicators is especially interesting for our study. For nominal convergence, full
set of the Maastricht criteria was analysed, while real convergence was tested
using real exchange rates and the real per capita GDP data. Authors employed
co-integration and common trends techniques, using official data span that
goes back as far as ten years from the year of entry, and found that the coun-
tries of interest partially converged with the two core EMU countries (France
and Germany) in terms of monetary policy as well as economic structures. Full
convergence is evidenced only in co-movements of inflation differentials, while
data showed no convergence at all in case of two fiscal variables, namely, defi-
cit to GDP ratio and public debt to GDP ratio.
Real convergence becomes important issue in our discussions, as it captures
long-standing benefits of lower-income countries to join the EU. Their ultimate wish
is to have income level and living standards of developed Western democracies.

452
However, what is real convergence, at all? What should converge and how
can we measure it? By real convergence, opposite to nominal one, we mean
that vital measures of economic performance and success moved or tend to
move in direction that discrepancies (gaps) between two units (countries or
regions) get decreasing or disappearing. What is appropriate to use in order
to present economic success based on increase of productivity (rise in val-
ue added per hour of employee)? The best measurable candidate is real per
capita (GDP) growth (controlled for the equality of income distribution), while
some other more direct measures of welfare are worth considering, e.g. life
expectancy, unemployment rate, social deprivation, calorie consumption, avail-
able living space etc. (Dauderstädt, 2014). From the technical (measurement)
point, based on well-accepted literature there are two basic indicators of con-
vergence/divergence and consequently two concepts. We can either measure
statistical dispersion of the chosen variable within the group of units, which is
known as sigma convergence, or measure the rate of convergence based on
speed at which units with lower initial value increase relative to units with higher
initial value, known as beta convergence (Barro, 1991).
From the empirical point of view, there are no strong empirical records that
regionally integrated countries outperform autarchic areas in terms of their
potential to catch up with their better-performing peers. Further on, it seems
that it does not even ensure real convergence between members of economic
integration. There are a number of studies that investigate the convergence/
divergence empirics within integrated Europe with overall result of earlier stud-
ies being inclined to existence of real convergence trend, though the estimates
indicate various strengths of the catching-up process (for a review see Dauder-
städt, 2014). Novel research that covers period after the global crisis not only
contradicts previous results but also questions the above finding in the sense
that the optimistic results now apply only temporary. The growth in Southern
Europe periphery not even failed to converge to that of the core, but also turned
into full-blown economic recession.
The distinction between nominal and real convergence is very important for the
political economy. Nominal convergence, as defined in the Maastricht criteria
for EMU, is mainly the interest of EMU, while real convergence captures the
best hopes of accession countries. Much less stress in accession negotiations
are put on real convergence since disappointing results in that manner will not
put the entire integration project in danger and harm the interests of the club of
existing members. Therefore, for the EMU, which imposes the rules on candi-
dates, nominal convergence criteria look like “right” instrumentarium to reach
“false” goal of real convergence, while for the candidate countries, the criteria
may look like “wrong” instrumentarium to reach a “genuine and ultimate” goal.
Thus, dichotomy between nominal and real convergence is just a manifestation
of dichotomy of interests of those two groups of countries.

453
An open dilemma for acceding countries is how much their commitment to
nominal convergence criteria may go without sacrifices, i.e. output and em-
ployment losses (Rossi, 2004). It is a question of aligning stability to growth
goals. From the very beginning, EMU have had a problem with initiating real
convergence, probably because nominal convergence was put in the forefront
of policy discussions, as the first and foremost goal. The vast experience of
previous enlargements shows that real convergence is lagging behind nomi-
nal convergence. Moreover, Tykhonenko (2013) found that fifth enlargement
(CEECs) led to a variable-speed Europe of real convergence, while Bação et
al. (2013) found that deterioration of key macroeconomic variables appeared
after Portugal adapted common currency. Therefore, historical experience told
us that the success of the process of nominal convergence can be expected
at the expense of real divergence among the member countries. For, nominal
convergence, which is defined in the Maastricht Treaty as a set of require-
ments need to be fulfilled by countries intending to join the EMU, requires clear
stabilisation-oriented policy. In order to boost economic growth, improve the
well-being of population, a new EU member should significantly increase public
investments and speed up the restructuring of its economy and other structural
reforms. These undertakings may be strongly infringed with the policy strictly
oriented to financial (nominal) stabilisation. Thus, a rational path for an acced-
ing country is to postpone EMU entry and work hard on tasks that will help
undergo real convergence (Rossi 2004).

5. Empirical analysis
The analysis used data for 40 countries, 28 EU countries (Austria, Belgium,
Bulgaria, Croatia, Cyprus, Czech Republic, Denmark, Estonia, Finland, France,
Germany, Greece, Hungary, Ireland, Italy, Latvia, Lithuania, Luxembourg, Mal-
ta, Netherlands, Poland, Portugal, Romania, Slovakia, Slovenia, Spain, Swe-
den, United Kingdom) and 12 countries that are not members of the European
Union, but with a tendency to become a member (Serbia-Candidate since 2012;
Montenegro-Candidate since 2010; Bosnia and Herzegovina-Potential Candi-
date since 2014; Macedonia-Candidate since 2005; Albania-Candidate since
2014; Moldova, Ukraine and Georgia - signed Association agreement with EU
in 2014; Belarus, Azerbaijan and Armenia-Members of the Eurasian Economic
Union; Switzerland – Withdraw its Application for the Membership in 2016) in
the period from 2000 to 2014. The variables used in the analysis have their
starting point in the convergence criteria also, but they were primarily selected
as the most important macroeconomic indicators that provide an insight into the
level of the economic development of the countries surveyed. The analysis in-
cluded: GDP per capita (PPP, current international, $); current account balance
(% of GDP); real interest rate; trade (export plus import as % of GDP); GDP
per capita growth (annual percentage change); cash surplus/deficit (% of GDP;
cash surplus or deficit is revenue (including grants) minus expense, minus net
acquisition of non-financial assets. In the 1986 GFS manual non-financial as-

454
sets were included under revenue and expenditure in gross terms. This cash
surplus or deficit is closest to the earlier overall budget balance (still missing
is lending minus repayments, which are now a financing item under net acqui-
sition of financial assets); FDI net inflows (% of GDP); FDI net outflows (% of
GDP); general government final (GGF) consumption expenditure (% of GDP);
gross national expenditure (% of GDP); gross savings (% of GDP); expense (%
of GDP); deposit interest rate (in %); government expenditure on education (%
of GDP); gross capital formation (% of GDP); long-term unemployment (% of
total unemployment); merchandise trade (% of GDP); money and quasi money
M2 (% of GDP); research and development expenditure (% of GDP).
The sources of the data are statistical database of the European Union (Eu-
rostat) and the statistical database of the World Bank (World Bank Data). The
essence of the analysis is to identify those variables that proved to be the most
important indicators of successful membership in the European Union whose
value reflects the possibility of enjoying all the benefits of membership.
Statistical analysis shows that the difference of mean values regarding inflation
rate, final consumption expenditure, GDP per capita, consumption expenditure,
gross national expenditure and current account balance between members and
non-members of the EU are statistically significant (Table 1).

Indicators Not member of EU Member of EU p

Inflation rate 3.72 ± 5.77 0.21 ± 0.75 0.031
Final consumption expenditure 88.14 ± 16.72 75.79 ± 8.26 0.012
GDP per capita 15.50 ± 14.44 35.72 ± 15.66 0.000
General government final 15.64 ± 3.60 20.03 ± 3.30 0.004
consumption expenditure
Gross national expenditure 110.71 ± 15.59 95.78 ± 7.24 0.002
Gross capital formation 23.59 ± 6.00 20.11 ± 3.60 0.082
Current account balance –4.84 ± 8.13 1.59 ± 3.87 0.021

Table 1. Difference of mean values for selected indicators

Source: authors’ calculations

Regression analysis is used to determine the intensity of the changes of the

dependent-variable variable that are associated with changes in the independ-
ent-variable variables. Using the regression model, it is possible to determine
the relationship or association between the dependent and independent varia-
bles, and in such a way that it can determine to what extent the change of the
dependent (categorical) variable is caused by a change of the independent
variable. Logistic regression enables testing the model for prediction of cat-
egorical outcomes with two or more categories. Binary logistic regression is
used to investigate the dependence of a binary variable to one or more inde-
pendent variables. The binary variable is usually taken to be the value of 0 or 1.

455
Independent variables can be numeric and categorical. These variables are
called the predictor variables, because by using them the probability of a binary
variable that receives the value 1 is predicted. The aim of the application of the
statistical methods described above is to identify the variables that have the
greatest impact on the change of the categorical variables (membership in the
EU) through the univariate and multivariate regression analysis.
The univariate binary regression analysis indicated that the membership in the
EU is significantly affected by the current account balance (% of GDP). The
odds ratio is 1.250, which means that its increase by one increases the chance
for the country to become an EU member by 25%. Gross domestic product
per capita has been confirmed as statistically significant for the EU member-
ship. The odds ratio is 1.172 which means that its increase by 1, increases
the chance for the country to become an EU member by 17.2%. Final con-
sumption expenditure, has a significant impact on the EU membership. Final
consumption expenditure (formerly total consumption) is the sum of household
final consumption expenditure (private consumption) and general government
final consumption. The odds ratio is 0.907, which means that its increase by
one, decreases the chance for the country to become an EU member by 9.3%.
Similar results are for the gross national expenditure. This measure is the
widest of all tested consumption measures. Apart of private (household) final
consumption and general government final consumption it includes also gross
capital formation (formerly gross domestic investment). The odds ratio is 0.856,
which means that its increase by one, decreases the chance for the country
to become an EU member by 14.4%. The odds ratio for general government
final consumption expenditure (formerly general government consumption) is
1.578, which means that its increase by 1, increases the chance for the country
to become an EU member by 57.8%. This measure of aggregate consumption
includes all government current expenditures (goods and services purchased
and compensation of employees) and excludes expenditures that go to govern-
ment capital formation category. Thus, it is included in both final consumption
expenditures and gross national expenditures. The membership is also signifi-
cantly affected by gross capital formation. The odds ratio is 0.836, which means
that its increase by one, decreases the chance for becoming an EU member by
16.4%. Inflation also shows significant impact. The odds ratio is 0.431, which
means that its increase by one, decreases the chance for becoming an EU
member by 56.9%.
Following the univariate binary logistic analysis and separation of variables that
affect the individual membership in the EU, a multivariate regression analysis
was applied, including the previously excluded variables in the model. Multivar-
iate binary logistic regression shows that final consumption has a significant
impact on the EU membership. The odds ratio is 0.723, which means that its in-
crease by 1000, decreases the chance for the country to become an EU mem-
ber by 27.7%. Significant impact also shows GGF consumption expenditure.

456
The odds ratio is 3.091 which means that its increase by 1000, increases the
chance for the country to become an EU member 3.091 times. Gross capital
formation has indicative effect on membership to the EU (close to statistical
significance). Results are shown in Table 2.

Indicators Univariate binary regression Multivariate binary regression

Odds ratio p Odds ratio p
Inflation rate 0.431 (0.204–0.912) 0.028
Final consumption 0.907 (0.840–0.979) 0.012 0.723 (0.545–0.960) 0.025
expenditure
GDP per capita 1.172 (1.057–1.301) 0.003
General government 1.578 (1.121–2.220) 0.009 3.091 (1.147–8.324) 0.026
final consumption
expenditure
Gross national 0.856 (0.765–0.957) 0.006
expenditure
Gross capital 0.836 (0703–0.995) 0.044 0.744 (0.526–1.052) 0.094
formation
Current account 1.250 (1.059–1.475) 0.008
balance
Table 2. Univariate and multivariate binary regression
Source: authors’ calculations

Used multivariate binary logistic regression provides the following model:

Model = 100·esum(1 + esum) (1)

where is sum = – 0.324·Final consumption expenditure + 1.128·GGF con-

sumption expenditure – 0.296·Gross capital formation + 13.877.

We used new variable, named Model, whose value can be calculated for all
countries that are included in analysis. For example, Serbia has a value model
30.48, Montenegro 11.00, Austria 99.66, Bulgaria, 75.73. etc.
The ROC curve is a graphical representation of the sensitivity and specificity
for each possible boundary score in the coordinate system, where the values
of sensitivity (probability of detecting the presence of the correct attribute) are
shown on the ordinate (y), and the abscissa (x) shows the values of specificity
(probability of incorrect detection of the presence of the feature).

457
 Figure 1. ROC curve

ROC curve shows that our model can be an excellent marker for distinguishing
between EU member states and non-member countries (area=0.976, p<0.0005).
Cut-off is 55, the sensitivity and specificity were 0.963 and 0.909. This means
that 96.3% of the EU member states has a value greater than our model 55, and
90.9% non-member has the value of our model that is less than the 55.

6. Results and discussion

Analysing 40 countries, all 28 EU countries and 12 countries aspiring to be-
come its members, for the period of 14 years and the use of a large number of
macroeconomic variables, which found its footing in the criteria of a common
currency, and from them derived the convergence criteria, it is shown that GDP
per capita is a statistically significant indicator of the membership in the Euro-
pean Union. The subsequently conducted univariate analysis indicated that the
membership in the EU is significantly affected by the current account balance.
The impact of GDP per capita has been confirmed as statistically significant for
the EU membership. Similar results we have got for final consumption expendi-
ture, the gross national expenditure and inflation. Following the univariate bina-
ry logistic analysis and separation of variables that affect the individual mem-
bership in the EU, a multivariate regression analysis was applied, including in
the model previously excluded variables. Multivariate binary logistic regression
shows that consumption expenditure variables have significant impact on the
EU membership, with gross capital formation that has only indicative effect on
membership in the EU (close to statistical significance). Interestingly, it appears

458
that a lower share of private (household) final consumption and a higher share
of government final consumption in GDP increases the likelihood of a candi-
date to become a member of EU. Although we cannot be sure of the impact of
domestic investment on chances to become a member, it seems that it is neg-
ative. It is hard to give a rationale for the observed regularities. One possible
answer is that the increase in governmental spending was needed (for example
during the preparatory phase) in order to strengthen institutional capacities for
accession. As an alternative answer, it could be simply that the countries that
initially formed EU, and entered EU in successive enlargements, largely had
higher government spending as a common economic feature.
Our model based on ROC curve allows reasonably accurate classification of
countries on member and non-member countries, and sorting of potential can-
didates with respect to achieved criteria. From economic point of view, that is
confirmation of importance of reaching a threshold defined in macro-economic
indicators which have confirmed a statistically significant difference between
members and non-members of the EU, and only then a country should become
a full member of the wider community. Otherwise, it would be on the side-lines,
without much benefit for itself and for the Union as well. The new variable which
we created shows that for all new entrants it is very important to reach this level
(cut-off) of 55, that is, to make their economic position strong already in pre-ac-
cession process. That should help policy-makers to make adequate decisions
in the present, which would contribute to achieving macroeconomic resilience
in the future.

7. Conclusion
The European Union has been exposed to numerous challenges. Some of
them were concerned to the question of her survival and possibility to grow. The
fact that we have today the Union composed of 27 countries, with intention of
getting larger in the future, confirms the straight and power of the EU. There will
be new problems for the EU and potential candidates in the future and therefore
is very important for both to strengthen own capacities. This analysis can help
to define priorities in developing process for future members, in order to make
Union a better place for achieving own goals.
As above theoretical analysis shown, there are many advantages and disad-
vantages of regional integration. Depending on foreseen balance between ben-
efits and costs, countries should decide whether they want to become part of
the European Union or want their further economic development to be based
on the pre-existing institutional frameworks. The Western Balkan countries
have recognised the regional integration as optimal way to achieve their prima-
ry goal of economic prosperity. Despite that every country faces specific chal-
lenges, this analysis is intended to find the common macroeconomic, measura-
ble indicators, that would indicate capability of accession states to successfully
achieve development goals.

459
The subsequently conducted univariate analysis has indicated that the mem-
bership in the EU is significantly affected by the current account balance (%
of GDP). The impact of GDP per capita has been confirmed as statistically
significant for the EU membership. Similar results are for final consumption
expenditure, the gross national expenditure and inflation. Following the uni-
variate binary logistic analysis and separation of variables that affect the indi-
vidual membership in the EU, a multivariate regression analysis was applied,
including the previously excluded variables in the model. Multivariate binary
logistic regression shows that final consumption has a significant impact on
the EU membership. Significant impact also shows consumption expendi-
ture. Gross capital formation has indicative effect on membership in the EU
(close to statistical significance). Such results should be understood as a reg-
ularity based on past enlargements experiences, with limited guidance for
perspective undertakings.
The process of obtaining a full membership in the European Union is typically
lengthy, exhaustive and is not time-limited. The moment of obtaining full mem-
bership is conditioned by numerous factors, some of which are economic in
nature, but the factors that are political in nature have got a huge role, as well.
This primarily relates to the political will of the European Union member coun-
tries for granting additional enlargement of the Union.
However, the experience of the countries that have joined the European Union,
as well as those who have given up monetary sovereignty and adopted the
euro, indicates the importance of selecting the timing of accession in terms of
the achieved economic development, expressed through the selected macro-
economic indicators.

460
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 CHAPTER 27

Reference Model and Architecture

for the Post-Platform Economy

Mirjana Radonjic-Simic1, Sebastian Richter2, Dennis Pfistere3

ABSTRACT

We define a post-platform economy as an economy that does not rely on intermediating

platforms (or mega-platforms such as Amazon, Alibaba, and eBay) to conduct commer-
cial transactions on the Internet. In a post-platform economy, everybody or everything
connected to the Internet can act as a consumer and/or a provider of so-called complex
products without requiring intermediating platforms. We define complex products as highly
personalized combinations of individual products and services required to fulfill a particular
consumer-defined need. Contemporary online markets work well for individual products
and services or predefined combinations of them; they fall short in supporting complex
products. Also, current online markets concentrate power on intermediating platforms and
hence increase the “positional power” of these platforms leading towards a de-facto cen-
tralization of previously decentralized online markets. That increases transaction costs for
consumers trying to find optimal product/service combinations and thus, satisfying such
personalized needs. To address these issues, we propose a novel reference model for
the post-platform economy and present an accompanying architecture as an example for
a concrete implementation. This Decentralized Market Space Architecture (DMSA) is a
strictly decentralized and highly scalable architecture to facilitate post-platform economy
scenarios. It empowers consumers and providers to engage and conduct transactions
of complex products in a direct, peer-to-peer manner, and without any central instance
of the control. DMSA lowers transaction costs for complex products by supporting the
market transactions divided into activities related to 1) formulating demand (composing
and requesting arbitrary complex products), 2) negotiation (matching), 3) contracting, 4)
settlement and 5) after-sales activities like reviews and dispute management.

Key words: Post-Platform Economy, Decentralized Marketplaces, Market

Transactions, Complex Products

JEL classification: A10, A12, A13

1 Research Assistant, Baden-Wuerttemberg Cooperative State University Mannheim, Business

Informatics, Coblitzallee 1-9, 68163 Mannheim, Germany. Scientific affiliation: Business Ecosys-
tems, Ecosystem-oriented Architectures, Phone: +49 621 41050. E-mail: mirjana.radonjic-simic@
dhbw-mannheim.de.
2 Professor, Baden-Wuerttemberg Cooperative State University Stuttgart, Rotebühlplatz 41,
70178 Stuttgart, Germany, Phone: +49 711 1849-4526. E-mail: sebastian.richter@dhbw-stuttgart.de
3 Professor/PD, University of Lübeck, Telematics, Ratzeburger Allee 160, 23562 Lübeck, Ger-
many. Scientific affiliation:,Internet of Things (IoT),Cyber Physical Systems (COS), Semantic Web
Phone: +49 451 3101 6404. E-mail: pfisterer@itm.uni-luebeck.de

465
1. Introduction
In this paper, we introduce a novel reference model and architecture for the
post-platform economy. We define a post-platform economy as an economy
that does not rely on intermediating platforms (or mega-platforms such as Am-
azon4, Alibaba5 and eBay6) to conduct commercial transactions on the Internet.
In a post-platform economy, everybody or everything connected to the Internet
can act as a consumer and/or a provider of so-called complex products without
requiring intermediating platforms. We define complex products as highly per-
sonalized combinations of individual products and services required to fulfill a
particular consumer-defined need.
Contemporary online markets work well for individual products and services or
predefined combinations of them; they fall short in supporting complex prod-
ucts. In addition, current online markets concentrate power on intermediating
platforms and hence increase the positional power of these platforms leading
towards a de-facto centralization of previously decentralized online markets7.
This increases transaction costs for consumers trying to find optimal product/
service combinations and thus, satisfying such personalized needs.
To address these issues, we propose a novel reference model for the post-plat-
form economy and present an accompanying architecture as an example for
a concrete implementation. This Decentralized Market Space Architecture
(DMSA) is a strictly decentralized and highly scalable architecture to facilitate
post-platform economy scenarios. It empowers consumers and providers (so-
called peers) to engage and conduct transactions of complex products in a
direct, peer-to-peer manner, and without any central instance of the control.
DMSA lowers transaction costs for complex products by supporting the market
transactions divided into activities related to 1) formulating demand (composing
and requesting arbitrary complex products), 2) negotiation (matching), 3) con-
tracting, 4) settlement (payment and delivery), and 5) after-sales activities like
reviews and dispute management.
The remainder of this paper is structured as follows. First, Section 2 describes
the context in which the proposed reference model and architecture can be
applied. Following, Section 3 presents the reference model for transactions
of complex products in a post-platform economy. Section 4 presents our ac-
companying architecture as an example for a concrete implementation. Finally,
Section 5 concludes this paper with a summary and outlook.

4 http://www.amazon.com
5 http://www.alibaba.com
6 http://www.ebay.com
7 OMG (2015) Business Process Model and Notation Version 2.0.

466
2. Background and Motivation
In this section, we describe the context in which the proposed reference model
and architecture can be applied. First, we outline main characteristics of com-
plex products in Section 2.1 followed by the definition of primary objectives of
an electronic market environment aiming to support transactions of complex
products (Section 2.2).

2.1. Complex Products

Consider the simple use case of a tourist who is planning a city trip. Assume
that this trip includes a flight, accommodation, guided tour, and travel insur-
ance. From the commercial point of view, our tourist is a consumer looking for a
personalized combination of services mentioned above that need to fulfill a par-
ticular context. In this case, that can be requirements, and constraints related
to, e.g., schedule, budget and other personal preferences like disabled-friendly
accommodation.
The use case of a tourist planning a city trip is a prototypical example for a
class of real-life problems consumers face when looking for the satisfaction
of a highly personalized demand. Such arbitrary combinations of individual
products and services (that are required to satisfy a specific consumer’s need
based on a consumer-defined context) are called complex products (Schmid,
Lindemann, 1998 : 193–201), (Radonjic-Simic, Pfisterer, 2017).
Thereby, the context is understood as a broader range of information to provide
a richer description of a consumer’s demand more specifically. Besides the
desired products or services, it might encompass details about the required
combination. Examples are general constraints such as price or payment and
delivery modalities. Also, this includes information about contextual require-
ments such as time, place, reviews, and recommendations by trusted social
contacts and online communities.

Figure 1. Visualization of complex product scenarios

467
A complex product scenario denotes a set of involved parties (consumers and
providers) who interact to satisfy a consumer’s need represented through a
transaction of a particular complex product. Figure 1 visualizes such scenari-
os and shows consumers demanding complex products (CPs) and providers
offering parts of complex products (as indicated by dotted lines). As illustrated,
consumers might participate in different scenarios being consumer or provider,
or both at the same time. Take for example the circled participant, who is at the
same time a consumer looking for (i.e., the initiator of ) and provider in .
Based on that and the scenario analysis conducted in earlier work by (Radon-
jic-Simic, Pfisterer, 2017), complex product scenarios can be characterized as
consumer-centric, transaction-oriented and distributed.
A complex product scenario is considered consumer-centric as it is, initiated by
a consumer demanding a personalized product/service combination to satisfy
a particular need. In the case of our tourist, this is a combination of a flight,
guided tour, accommodation, and insurance with the condition to meet several
constraints such as overall budget and schedule, and disabled-friendliness.
Furthermore, such a scenario is transaction-oriented as the primary intention
is not only to request complex products but to conduct a market transaction
for such a product. Thereby, a market transaction corresponds to a finite num-
ber of interaction processes among participants (consumer and providers) with
the goal to initiate, arrange, and complete the contractual agreement for the
exchange of products and services in the most efficient way (Selz, Schubert,
1998 : 222–231).
Finally, the distributed nature of a complex product scenario refers to the dif-
ferent business domains a complex product might span. In our use case, it
spans four different domains (flight, event, accommodation, and insurance) and
requires providers from these domains to deliver distinct parts of the complex
product to satisfy the consumer’s need.

2.2. Overall Objectives

The identified characteristics of complex product scenarios impose a set of ob-
jectives on the electronic markets that aim to support them. Given that, and re-
ferring to our work in (Radonjic-Simic, Pfisterer, 2017, Moazed, Johnson, 2016)
the primary objectives can be summarized as follows:
• Objective 1: Enabling transactions of complex products in a trustful and
reliable manner. On the consumer-side, this increases efficiency and
alleviates the effects of adverse selection (i.e., choosing good enough
instead of optimal). And providers gain higher accessibility of their of-
ferings and an increased level of personalization related to the consum-
er-defined context.

468
 • Objective 2: Facilitating integration, the simplicity of use and manage-
ment. For market participants (consumers and providers), it empowers
them by providing tools and services to constitute and evolve their mar-
ketplace. An environment that enables them to initiate and participate
in different context-centric, dynamic and transaction-oriented business
scenarios.
• Objective 3: Supporting scalability and allowing transactions in any busi-
ness-domain. Since complex products can be arbitrary complex combi-
nations of individual products and services spanning different domains,
the marketplace as a trading environment has to be open for any busi-
ness domain and allow cross-domain transactions.
We will use the formulated objectives as a rationale for the conceptualization of
our reference model and architecture in the following sections.

3. Reference Model for Transactions of Complex Products

This section describes the elements of our novel Reference Model for Transac-
tions of Complex Products. Our model extends the Reference Model for Elec-
tronic Markets (RM-EM) by Schmid & Lindemannintroducing elements that ac-
knowledge the specifics of complex products described in the previous section.

3.1. Related Work

The RM-EM (Selz, Schubert, 1998 : 222–231) (cf. Figure 2), is a well-recog-
nized and widely used reference model for the design and conceptualization of
electronic markets (i.e., electronic marketplaces). The term electronic market-
place refers to a market-oriented organization of commercial exchange, aim-
ing to increase market transparency, lower transaction and coordination costs
(Bakos, 1998). An e-marketplace serves three main functions: 1) to match de-
mand and supply, 2) to facilitate market transactions, and 3) to provide the
institutional infrastructure (Bakos, 1998), (N. & Gebauer, 2000).

469
Figure 2. Reference model for electronic markets
Source: Selz,, Schubert (1998)

As shown in Figure 2, the RM-EM consists of two dimensions. The horizontal

dimension represents the market transaction and the vertical dimension groups
the four views.
The market transaction (see Figure 3) comprises three phases: Information,
Agreement, and Settlement. During the Information Phase, market participants
acquire a market overview by gathering information about goods and services
and potential transaction partners. For a market participant, the phase ends with
an offer. The receipt of an offer is considered to be the start of the Agreement
Phase when market participants negotiate conditions of transactions and agree
on a legal-binding contract. The agreed contract is fulfilled in the Settlement
Phase, which involves activities related to payment, delivery, and logistics.

Figure 3. Phase model of market transaction

Source: Selz,, Schubert (1998)

470
The vertical dimension of the RM-EM refers to views organized in four layers:
Business, Transaction, Services, and Infrastructure. While the upper two views
focus on organizational aspects of an e-marketplace (i.e., business model,
business processes, and scenarios), the lower two focus on technological as-
pects. The Service View specifies the market services available to the market
participants. These are Electronic Product Catalog supporting the information
exchange between market participants, Contracting for negotiation and con-
tracting, as well as payment and logistics. The Infrastructure View represents
the information and communication infrastructure required to support market
transactions by implementing market services defined in Service View.
As to the reviewed literature, the RM-EM has been expanded and adapted to
the prevailing conditions of specific market domains (i.e., business-to-business,
business-to-customer, etc.). Selz & Schubert propose a new phase Commu-
nication to support interactions between market participants that happen af-
ter the Settlement phase (e.g., activities related to refund and reviews). Picot,
Reichwald & Wigand (Searls, 2013), Kollmann (Radonjic-Simic, 2018) also
propose an additional phase After-Sales to support activities, e.g., dispute and
extended customer relationship management. But also to use the established
relationships to offer additional market services like, e.g., recommendations
and advertising. Additionally, an extension of the Service View is proposed by
(Radonjic-Simic, 2018), introducing the e-fulfillment tool, provided by the trust-
ed intermediary (i.e., a marketplace operator) to ensure an adequate level of
trust and arbitration in a mediated marketplace.
However, these adaptations of the RM-EM reflect a reality of electronic market-
places that are predominately supply-oriented and focused on transactions of
standardized products and services. To consider the reality of consumer-orient-
ed complex product scenarios, the initial RM-EM has to be adapted in a way
to acknowledge the specifics of complex products. The adapted model forms
the conceptual basis for designing electronic marketplaces suitable for trans-
actions of complex products.

3.2. Proposed Reference Model

The proposed reference model for transactions of complex products enhances
the original RM-EM in order to support the specifics of interaction process-
es between market participants engaged in complex product scenarios. Fig-
ure 4 shows the Reference Model highlighting the proposed extensions with
bold lines.

471
Figure 4. Proposed Reference Model for Transactions of Complex Products.

Changes refer to:

• the horizontal dimension of the RM-EM. We suggest new phases analo-
gous to the underlying phase model of market transactions (cf. Figure 3);
• the vertical dimension: we propose additional elements of the Service
View required to support each of the suggested phases.

3.3. New phases Negotiation, Contracting, and Relationship

In contrast to the phase model of market transactions (cf. Figure 3), our model
encompasses five phases. As depicted in Figure 5 our model introduces two
new phases after the Information phase (Negotiation and Contracting) instead
of the original Agreement phase.

472
 Provider Consumer

Information Phase
Indvidual Complex
Product Product
Offerings Request

Negotiation Phase
Complex
Product
Proposal

Contracting Phase

Complex Product Contract

Settlement Phase

Fulfillment

Relationship Phase

End of Complex Product Transaction

Figure 5. Phase model of market transaction of complex products.

The main reason is the necessity to support different interaction processes

among market participants. In the case of standardized products and services,
the Information phase supports searching and choosing offerings from exist-
ing product catalogs and ends with an offer (cf. Figure 3). But for consumers
looking for a complex product (except in case of a pre-defined one), such an
offering cannot be found in existing product catalogs. Instead of searching for
offerings, a consumer first needs to formulate demand in the form of a complex
product request. This request is used to search for potential providers that can
provide parts of the required complex product. Consequently, the Information
phase ends with a formulated complex product request and a list of possible
transaction partners.
Following, the market participants require a phase to negotiate conditions for
an agreement regarding all parts of the complex product. For the consumers
it means, sending “Requests for Offer” (RfO) to providers, then aggregating all
received offerings and creating complex product proposals, as well as, ranking
them based on the defined requirements and constraints. A consumer might
then select one complex product proposal, which best suits their requirements,
which is then the starting point for the Contracting phase and serves as the
basis for the contractual agreement to be made.

473
The Contracting phase ends with a legal-binding complex product contract,
which in turn, is the starting point for the Settlement phase. After fulfilling the
contract, the transaction of complex products ends with the end of the Relation-
ship phase. The Relationship phase is the fifth phase we integrate following the
suggestion by Searls (2013), (Radonjic-Simic, 2018) to support activities that
might happen after sales.

3.4. Service View: Market Services for the support of market

transactions of complex products
Now that we have discussed the proposed phase model for the transaction of
complex products, we now suggest enhancements of the Service View by intro-
ducing the new elements Complex Product Tool, Negotiation, and After-Sales.
As indicated in Figure 4, the Service View layer differentiates between the pro-
vider and consumer side (with new elements highlighted in bold font).
Complex Product Tool: On the consumer side, we suggest a tool, which seam-
lessly bundles different services in order to provide support for complex prod-
ucts in the Information, Negotiation and Contracting phase. The complex prod-
uct tool should support processes and activities around the complex products
as discussed in the previous section, and summarized in Figure 5. These are a
consumer’s activities related to creating complex products, sending Requests
for Offers to potential transaction partners, and getting offerings, negotiation,
and ranking of complex product proposals, and finally contracting.
Negotiation: On the provider side, we suggest additional services to support the
part of the negotiation process that considers specifics of complex products.
Hence, the supplementary services, which enable providers to create offerings,
based on the contextual information of a particular product and as a part of the
complex product. In case of our tourist, this could be to offer a disabled-friendly
accommodation and guided tour, which in combination otherwise would not be
considered.
After-Sales: As an enhancement of after-sales tools proposed by (Radon-
jic-Simic, 2018) such as, e.g., refund, reviews, recommendation, and dispute
resolution management, we recommend further tools to facilitate sharing expe-
riences with a community interested in an exchange of complex products. As
well as, integration of advanced analytics tools to make available an up-to-date
market overview, and thus, facilitate market transparency, considered one of
three primary functions of a marketplace.

4. Reference Architecture for Transactions of Complex Products

Having introduced the proposed reference model for transactions of complex
products, in this section, we present our Decentralized Market Space Architecture
(DMSA). DMSA represents an example of a concrete implementation of the iden-
tified market services of the Service View as described in the previous section.

474
4.1. Related Work
This section reviews a set of related works and briefly discusses their suitability
to support market transactions of complex products.
E-marketplaces as market-oriented organizations operate predominately as
intermediated solutions focused on the supply-side of the market and individ-
ual products and services. In general, they support compositions of products/
services within their boundaries (i.e., industry, domain, type of products and
services) and support transactions of pre-defined product/service combination
traditionally purchased together. Examples are Opodo8 or Expedia9 that offer
combinations of flight, hotel, and rental car. However, they are limited in sup-
porting market participants in transactions of arbitrary complex products that
may span different domains and need to fulfill consumer-defined requirements
and constraints.
Decentralized Peer-to-Peer and blockchain-based marketplaces refer to the
concept of a disintermediated electronic marketplace that brings possible
transaction partners together and enables them to engage in market transac-
tions directly and without any intermediary (Kleedorfer, Busch, Pichler, Huem-
er 2014). Approaches such as, e.g., OpenBaazar (Bazaar, 2016), BitMarkets
(Picot, Reichwald, Wigand, 2003), and OpenMarket (Pfisterer, Radonjic-Simic,
Reichwald, 2016) propose different infrastructure solutions. They are frame-
works and architectures that support the phases of the market transaction in a
decentralized and peer-to-peer manner (preferably using cryptocurrency). But,
as with intermediated e-marketplaces, these solutions are focused on market
services necessary for the transaction of individual products and services, and
thus, fail short in supporting complex products.
The Intention Economy (EI), introduced by Searls 2013, refers to an electronic
market that is demand-oriented and focused on the buyer’s demand as the pri-
mary driver of market transactions. The main idea of IE is to equip buyers with
Vendor Relationship Management (VRM) tools (Eymann, T. (2001) that make
them independent in their relationships with vendors (i.e., providers) and other
participants on the supply-side of markets. The VRM tools support consum-
ers in activities related to the Information and Negotiation phase (i.e., creating
a personal request for proposal (pRFP), making them visible to vendors and
identifying the best and final offers (BAFO)). But, there is no obvious evidence
that VRM tools can support the contracting and settlement activities, nor the
description of buyer’s demands spanning different product/service domains.
Web of Needs (WoN, Kollmann, T. (2010) is a framework for a distributed and
decentralized marketplace on top of the Web. Its main idea is to standardize the
creation of owner-proxies as the central entity controlled by market participants
(buyers and sellers). Owner-proxies describe a demand (i.e., a need) on the

8 http://www.opodo.com
9 http://www.expedia.com

475
buyer side, offered products/services on the provider side, and contain the in-
formation about the owner that is required to start a transaction. Once created,
owner-proxies are published to the Web, where they are made aware of each
other by independent matching services, which compare their descriptions and
inform them about possible transaction partners. If a buyer needs a complex
product, he can publish a “complex need” waiting for a suitable matching ser-
vice capable of interpreting and matching with potential transaction partners.
But, the WoN does not go beyond starting the conversation between market
participants. It does not support activities beyond the Information phase of a
market transaction for complex products.
Concluding remarks: Contemporary solutions and concepts work well for indi-
vidual products and services but are limited to supporting complex products.
Concepts such as IE or WoN address some of the objectives but do not rep-
resent a comprehensive solution – either they provide tools that need to be
integrated, or support transaction phases only partly. Hence, considered insuf-
ficient to support market transactions of complex products.

4.2. Decentralized Market Space Architecture

Distributed Market Space Architecture (DMSA) empowers market participants
(consumers and providers) to constitute a market environment where they can
conduct complex product transactions in direct, peer-to-peer manner. DMSA is
strictly decentralized, highly scalable, and represents a conceptual structure of
a software-system required to support market transactions of complex products.
Figure 6 illustrates the proposed architecture and shows its core entities Peer,
Decentralized Market Space (DMS), and Peer Application.

Figure 6. Conceptual structure of distributed market space

476
 Peers represent market participants defined through their intention to consume
or provide for complex products. Peers can be everyone or everything con-
nected to the Internet (e.g., individuals, companies, institutions, or autonomous
agents acting on behalf of a peer taking different roles). Peers join the peer-
to-peer network and form a strictly decentralized market environment, in which
they can trade complex products directly and without any central instance of
the control.
Decentralized Market Space (DMS): The primary responsibility of the DMS is
to facilitate information exchange among market participants (i.e., peers). That
includes enabling direct communication among peers of interest and resolv-
ing information necessary for activities related to different phases of a market
transaction. For example, this can be information essential for matching peers
for a particular product/service, sending requests for offers and receiving offers
from addressed peers (i.e., Information and Negotiation phase).
As illustrated on Figure 6, DMS consists of an underlying peer-to-peer network
and a distributed Semantic Web database. The semantic database stores infor-
mation about registered providers and their offerings (i.e., product/service de-
scriptions), and the knowledge necessary for transactions in a particular domain
(i.e., domain knowledge). This domain knowledge is described by ontologies
and vocabularies, as well as terms of sales, and other domain-related condi-
tions and requirements. To this end, the semantic database is the foundation for
a product/service catalog required to supporting information exchange among
market participants in a decentralized market. For detailed information about the
implemented data model, examples of product/service descriptions and applied
ontologies, the reader is referred to (Radonjic-Simic, Pfisterer, 2017).

Figure 7. Functional structure of the peer application in relation to phases of a market transaction
of complex products.

Peer Application: The peer application is responsible for providing commu-

nication infrastructure for market participants (i.e., peers engaged in market
transactions of complex products). It represents the access point for a peer to

477
participate in the DMS and implements the market services identified in Ser-
vices View (cf. Section 3.2). The peer application is represented by the func-
tional structure, as summarized in Figure 7. As shown on the left, it encom-
passes (at least) seven components Complex Product Request Builder (CPR
Builder), (De-) Composer, Ranking, Coordinator, Registration, Offer Engine
and P2PCommunicator (Radonjic-Simic, Pfisterer, 2017). Each of these com-
ponents is involved in a particular phase(s) but taken together they cover the
whole market transaction of complex products, as illustrated on the right.

4.3. Inner Workings: Transaction of Complex Products

In this section, we provide additional details about the peer application compo-
nents and how they interact to support transaction phases. Thereby we focus
on the Information, Negotiation, and Contracting phase.
The process on the consumer-side starts with describing demand for a per-
sonalized combination of products and services, to satisfy a particular need.
The CPR Builder component enables consumers to create a complex product
request by composing an individual product/service combination integrating the
relevant contextual information. The output of this activity is a formulated com-
plex product request.

478
479

Figure 8. Information and negotiation phase

The diagram shown in Figure 8 illustrates the activities of market participants within the information and negotiation
phase. The activity flows are modeled using Business Process Modeling Notation 2.0 (BPMN 2.010). The upper-lane of
the diagram represents the consumer-side of the peer application and the bottom-lane the provider-side.

10 OpenMarket (2016) OpenMarket. Paper, B.W. (2016) BitMarkets.

 The (de-)Composer component decomposes complex product request into in-
dividual product/service requests, match providers for decomposed requests
and compiles a list of potential providers and sends the RfO (requests for of-
fers) to them. After receiving individual product/service offers, the composer
component re-combines all offers into multiple complex product proposals and
passes them to the Ranking component. Based on the consumer-defined re-
quirements, the ranking component ranks all complex products proposals in
a way that the best matching is on top of the list. A ranked list of proposals
(hence, a consumer’s decision about a preliminary agreement) is considered
the end of the Negotiation phase.
While previous components are designed to support peers in the role of a con-
sumer, the Registration and Offer Engine components support the activities of a
provider regarding description and registration of offered product/services, and
the negotiation process. That includes receiving the product/service requests
and sending offers back to the requesting peer (i.e., consumer). The offering
process can also encompass further functionalities depending on the type of
the peer (e.g., individuals, companies or institutions), the type of product/ser-
vice they offer and other provider-related characteristics.

Figure 9. Contracting phase

In case the negotiation phase ended with a viable complex product proposal,
which is also selected by the consumer, the contracting phase begins. Corre-
sponding activity flows are shown in Figure 9. The component of the peer ap-
plication responsible for the contracting on both sides (consumer and provider)
is the Coordinator.

480
From the consumer side, a complex product contract is considered as an um-
brella contract since it incorporates different arrangements for different parts of
the complex product. The umbrella contract represents one-to-many contract
situation and requires consumer’s involvement in several contractual process-
es (one for each product or service). The supporting activities on the consum-
er side (see Figure 9, upper-lane) ranging from wrapping a pending contract,
sending it to counterparts (providers), collecting confirmations and finally order-
ing. On the provider side, the activities covered by the Coordinator component
are slightly different. That is because the contracting process is considered as
a one-to-one contract situation with an additional activity regarding confirmation
of a pending contract. The result of the contracting phase is an agreed legally
binding contract.
Although the contracting phase ends here, the Coordinator is also responsible
for the activities in the settlement and relationship phase (see Figure 7), but
these two phases are considered out of the scope of this paper.

5. Conclusions and Outlook

This paper proposed a novel reference model for the post-platform economy
and presented the Decentralized Market Space Architecture (DMSA), an ac-
companying architecture, as an example of a concrete implementation.
The proposed reference model extends the Reference Model for Electron-
ic Markets (RM-EM) by Schmid & Lindemann and introduces elements that
acknowledge the specifics of complex products. That is, introduces three
new phases of the market transaction and new market services, identified
as essential to supporting market participants engaging in transactions of
complex products.
The introduced Decentralized Market Space Architecture enables consumers
and providers to engage and conduct transactions of complex products in a
direct, peer-to-peer manner and without any central instance of the control.
DMSA is described by its primary building blocks and functional components,
as well as their relationships and how they work together to realize transactions
of complex products.
However, this paper predominately covers the technology-driven aspects of
complex product scenarios and focuses on the Service and Infrastructure View
of the reference model. Therefore, in our future work, we will concentrate on the
organizational aspects of post-platform economy scenarios and their influence
on the Business and Transaction View with rather long-term impacts.

481
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 CHAPTER 28

Innovation expenditures efficiency in Central and

Eastern European Countries

Pawel Dobrzanski1

ABSTRACT

The purpose of this paper is to verify if money spend on R&D are used efficiently in
CEE countries. Nowadays, innovativeness is one of the most crucial factors accelerat-
ing economic growth. Increasing innovativeness is particularly important for developing
countries, where policymakers are implementing various innovation strategies. The Eu-
rope 2020 strategy sets the target of 3% GDP for R&D spending. Many studies empha-
size a significant effect of increasing expenditures on R&D on economic growth, but an
efficiency aspect has not been covered in the literature. The article is based on critical
review of the main literature of the subject and own empirical studies. The statistical data
is sourced from the main international statistics. Calculations were performed using the
method of DEA. DEA method allows to assess input-output efficiency. The calculations
are carried out based on the program Statistica 10. and Excel spreadsheet. The paper
gives a general review of the innovation level in CEE countries. The analysis shows that
among CEE countries, the most innovative is Czech Republic, which is spending the
most on innovation. However, hypothesis that increasing spending on innovations is not
causing proportional effects has been confirmed. Main conclusion of the research is that
innovation spending should be increased gradually in aim to achieve optimal results.
This research may contribute to discussion on innovation policy design, and can be
used by policy makers to develope national innovation strategies.

Key words: Innovation, Effectiveness, DEA Efficiency Method

JEL classification: H50, O30, O38, O57, R15

1. Introduction
Innovativeness of the economy is one of the key factors stimulating economic
growth. Many countries have an increased focus on developing the innovation
policy and strategy for their countries. Improving innovativeness is especially im-
portant for developing countries, which are trying to improve their competitiveness

* This paper is published in Proceedings of Rijeka Faculty of Economics-Journal of Economics

and Business/Zbornik Ekonomskog fakulteta u Rijeci: časopis za ekonomsku teoriju i praksu, Vol.
36, No.2, pp. 827-859, DOI: https://doi.org/https://doi.org/10.18045/zbefri.2018.2.827
1 Assistant Professor, Wroclaw University of Economics, Faculty of Economics, 118/120 Ko-
mandorska St, 53-345 Wroclaw, Poland. International Economics, +48601594346, e-mail:
pawel.dobrzanski@ue.wroc.pl

485
and stimulate economic growth. Many of the Member States of the European
Union are among the most innovative and developed economies in the World.
In 2004 ten post-transition countries joined the European Union from Central
and Eastern Europe. Since then, a concept of two speed Europe – competitive
and innovative old Members, and lower-income new Member States has be-
come a popular topic in the literature.
Innovation policy is important for the European Union. R&D spending in Europe
in 2010 was below 2% of GDP, while in the USA it was 2.6% and in Japan 3.4%.
This was result of lower levels of private investment. European Commission is
emphasising that there is a strong need to improve conditions for private R&D
in the EU. EU policymakers even set up a goal in the Europe 2020 Strategy
to ensure that 3% of GDP should be invested in R&D in all Members States.
As fiscal policy is likely to remain under pressure in many Members States,
public expenditures probably won’t increase significantly. Therefore, to reach
2020 target business expenditure should increase by 80% (Gros, Roth,2012).
“Innovation Union” was one of the initiatives created to improve conditions and
access to finance for research and innovation. The Commission launched it to
support regions and Member States in better defining their innovation strate-
gies by assessing their innovative strengths and weaknesses and build on their
competitive advantage (European Commission, 2013a). However, despite all
those activities, it is doubtful that 3% GDP goal will be achieved. EU’s spending
on R&D over last years remains almost at the same level around 2% of GDP.
Another question that can arise, is whether the level of 3% of GDP spending on
R&D is worthwhile and optimal for all Member Countries. Even in the Europe
2020 Strategy it is stated that the target focuses on input rather than output.
For EU policy makers it is clear that analysing R&D and innovation together
would get more relevant productivity drivers. Finally, the Commission proposed
to keep the 3% target, while developing an indicator which would reflect R&D
and innovation intensity (European Commission, 2010)
The aim of the study is to verify if money spend on R&D are used efficiently in
CEE countries. Main hypothesis of the research is that increasing R&D spend-
ing is not causing proportional innovative effects.
The paper is organized as follows. Second section presents literature review
regarding innovation in economic growth concept and innovation policies. Sec-
tion three describes DEA methodology. Section four presents data chosen for
analysis. Section five contains research findings and the last section concludes
the research.

2. Literature review
According to new growth theories long-term economic growth can be achieved
endogenously thanks to innovation and technological progress. The significance
of innovation for economic growth has been emphasized by many economists.

486
Concept of innovation was introduced by Schumpeter, who stated that, innova-
tive companies stimulate economic development and competitiveness by “cre-
ative destruction”. Innovations replace old products and technologies, having
a positive impact on the turnover outcome (Schumpeter, 2003). Gartner and
Drucker (1987) defined innovation as instrument of entrepreneurship, which
creates new opportunities to generate wealth. Solow (1956) stated that tech-
nological change, rather than capital accumulation, is the main driver of long-
run growth. Romer (1986) underlined importance of innovation and entrepre-
neurship in stimulating economic growth. Also, some empirical research are
confirming positive impact of innovation on economic growth. (Fagerberg &
Srholec, 2008; Hirooka, 2006; Taylor, Grossman & Helpman, 1993) Therefore,
innovation is nowadays at the center of each competitiveness strategy, both
company as well as government policies.
Literatures underline also the relationship between innovation and regulation.
Companies must have the willingness, opportunity, motivation, and capability
or capacity to innovate. Policy regulations can cause both positive and nega-
tive impact (Carlin and Soskice, 2006). EU regulation matters at all stages of
the innovation process, from R&D to commercialization. Regulation can be a
powerful incentive for innovative actions, but at times regulation can disable
innovation. The impact of the regulation on innovation depends on the balance
between innovation-inducing factors and compliance costs generated by legal
provision. (Pelkmans, Renda, 2014)
The aim of European Union is to improve its competitiveness through innova-
tion. The changing global landscape and the growing importance of innovation
require EU to review its innovation policy, including both the scope and the
governance of innovation at the EU and national level. Policymakers should
take into account the whole innovation cycle, including all links in the innovation
chain: industry, university, public and private financing organizations, society,
politicians, policymakers etc. The innovation policy should consider both the
supply and the demand for innovation. For that reason, the European Insti-
tute of Innovation and Technology (EIT) was established in 2007. The EIT is
the first European initiative that aims to integrate knowledge triangle, which
consists Higher Education, Research and Business-Innovation. EIT objective
is to improve innovation capacity and capability of the EU. However, still there
is no standard policy implemented in all Member States. Innovative goals are
announced at the EU level and Member States have full flexibility in their imple-
mentation. From one hand codified policy may simplify the sharing of common
technological solutions, removing trade barriers, enabling technology transfer,
and boosting the creation of complementary markets. But, in some cases it can
lead to undesirable results. (Anvret, Granieri, Renda, 2010)
The European Commission launched its innovation goals in the Europe 2020
Strategy, which announces seven flagship initiatives, of which at least five are
closely linked with innovation (Innovation Union, Digital Agenda, Resource Ef-
ficient Europe, A New Industrial Policy for the new globalization era and an

487
Agenda for new skills and jobs). Main goal of this strategy is to achieve smart,
sustainable and inclusive growth, improve its competitiveness and productivity
and underpin a sustainable social market economy. This should be guarantee
by 3% GDP spending on R&D (European Commission, 2010). The European
Council agreed that progress towards the Innovation Union should be meas-
ured at EU level and only R&D indicator is not reflecting full picture of countries
innovativeness. Therefore, the European Council organized high-level panel
with leading business innovators and economists to identify possible indicators,
which would best assess innovation intensity. New indicator should have focus
on outputs and impacts and facilitate international comparability. Moreover, the
European Council underlined urgent need of improving data availability and
quality to measure and monitor innovation performance. The Commission also
emphasized that, because innovation is a multi-faceted phenomenon, further
work is needed to develop indicators on aspects such as non-technological
innovation, design, service innovation, and performance at regional level. (Eu-
ropean Commission, 2011).
Both policy makers and researchers agreed that the R&D spending indicator
had certain limitations and is not correctly accessing innovative improvements
of the Member States. The use of R&D spending as innovative indicator is
widely criticized in the literature. Tilford and Whyte (2010) pointed out that EU
should not neglect R&D, but move beyond focus on numerical R&D targets
and provide the broader concept of innovation. Moreover, R&D is concentrating
mainly on the manufacturing sector, omitting service sector. EU is service-dom-
inated economy, with the highest share of service sector in GDP, which is sev-
eral times bigger than that of manufacturing. Gros and Roth (2012) also em-
phasized that European Union should utilise the broader concept of innovation,
named concept of intangible capital, which would align better with economic
structure of EU. Intangible capital concept includes capital, which is not includ-
ed in national accounts, such as: architectural design, new financial products,
own-account and purchased organizational structure of a firm, firm-specific
human capital, branding, market research and scientific R&D. Zabala-Itturia-
gagoitia (2008) has indicated that referring only to input indicators might result
in overrating unproductive R&D investment. Most of public R&D is used not to
stimulate economic growth, but to achieve public agency goals and any contri-
bution to economic growth is thus due to indirect knowledge transfers.
In 2013, the European Commission presented a new indicator to capture inno-
vation outputs, which can be used for measuring the EU’s progress in meeting
the goals of the Europe 2020 Strategy. Aim of the new indicator is to support
policy-makers in establishing policies to remove barriers that prevent innova-
tors from transforming ideas into successful products and services. The Indi-
cator of Innovation Output combines four output sub-indicators. First is tech-
nological innovation measured by number of patents. This indicator takes into
account knowledge generated by investing in R&D that can be transformed into
successful technologies. Second indicator, employment in knowledge-intensive

488
activities as a percentage of total employment, provides an economic orienta-
tion towards the production of goods and services with innovation added value.
Third indicator, competitiveness of knowledge-intensive goods and services, is
based on the share of high-tech and medium-tech products trade in the total
trade balance, and share of knowledge-intensive services in the total services
trade. Last indicator is employment in fast-growing firms of innovative sectors.
Stimulating jobs in such sectors is integral part of modern research and innova-
tion policy. This indicator provides a measure of the dynamism of the economy,
capturing relation between growth and jobs (European Commission, 2013b).
However, new innovation indicator solves only one problem. It supplements the
input perspective with an output perspective, but it tends to disregard actual in-
novation outcomes. Enterprises can transform innovation inputs, such as R&D,
human resources, research infrastructures and existing knowledge, in a first
stage into intermediate outputs, such as patents, and in a second stage, into
innovation outcome. Innovation outcomes are the results of the introduction of
innovations, among them the economic effects of innovation outputs on firms
introducing them. Patent application itself does not automatically have eco-
nomic results. For adequately measuring innovation outcomes at the country
level, both structural change and structural upgrading should be considered.
Structural change is reallocation economic activity towards more knowledge-in-
tensive sectors. Structural upgrading is getting closer to the frontier in sectors
countries are already specialised in. This is related to differential performance
of enterprises without necessarily changing the overall composition of the eco-
nomic structure, e.g. by moving to more knowledge-intensive activities within
the same sector (Janger et al., 2017). Unfortunally, statistics for innovative out-
comes are not conducted, due to difficulty in obtaining realiable data.
Innovativeness and innovative strategies and policies are widely described in
the economic literature. However, there is a lack of analysis of effectiveness of
R&D spending. Current studies are focusing either on inputs defined in innova-
tive policies or outputs achieved by countries or regions. Such an approach is
caused by both problems in defining efficiency and measuring it. The relation
between inputs and outputs need further investigation, which will be subject of
research in this article.

3. Methodology
Method employed in the research is Data Envelopment Analysis (DEA). DEA is
the nonparametric method used for efficiency measurement. The precursor of
this methodology was Farell (1957) and it was further developed by Charnes
et. al. (1978). DEA measures the efficiency of units with multiple outputs and
multiple inputs along with objectively determining weights. Equivalences are
established to ordinary linear programming models for effecting computations.
(Charnes et. al. 1978). DEA is a method for measuring comparative, relative
and so called technical efficiency. Efficiency is relative, as it measures effi-

489
ciency with reference to some set of units that are being compared with each
other. In general terms, the essential idea is to assess how efficiently each
decision-making unit (DMU) is handling the transformation process when com-
pared to other DMUs engaged in the same process. To do this relation between
outputs achieved and available resources it analyzed. DEA is not absolute
measure of efficiency. Units which are efficient in DEA methodology may in fact
be capable of improving their performance even further. The DEA model is an
input-oriented model, which seeks to identify technical efficiency as a propor-
tional reduction in input usage. (Thanassoulis, 2001) The efficient DMUs are
not necessarily production frontier, but rather best-practice frontier (Cook, Tone
and Zhu, 2014).
DEA can separate the efficient operating units from the inefficient on the basis
of whether they lie on the efficient frontier which is spanned by the best units in
a data set. The efficiency measure employed in DEA is established mathemat-
ically by the ratio of the weighted sum of outputs to the weighted sum of inputs
(Wober, 2007):

The first step in the application of DEA is to agree on relevant inputs and out-
puts. Inputs and outputs do not have to be measured in the same units. In DEA
the resources are typically referred as inputs and the outcomes as outputs.
Identification of the input-output variables used in an assessment is the most
important step. The results, which will be obtained in the research depend cru-
cially on the choice made. The input-output variables are unique to the type
of efficiency being assessed. The inputs should capture all resources, which
impact the outputs and the outputs should reflect all useful outcomes, on which
we wish to assess the DMUs. The identification of exogenous variables is im-
portant. Exclusivity and exhaustiveness of input-output variables must guide
the choice of the input-output variables subject to the exogeneity of any varia-
bles being proposed. (Thanassoulis, 2001) With DEA method the overall effi-
ciency of a DMU is measured by its total factor productivity output-to-input ratio,
which takes into account all outputs and all inputs. The main problem here is
choosing the inputs and outputs to be considered and the weights to be used in
order to obtain a complex overall measure (Wober, 2007).
Thanassoulis (2003) underlined that DEA method has many advantages. First
of all there is no need to specify a mathematical function of the effectiveness.

490
Moreover, DEA method can be useful in uncovering relationships that remain
hidden for other methodologies. DEA method allows analysing multiple inputs
and outputs at the same time, without any input-output measurement. In addi-
tion, the sources of inefficiency can be analysed and quantified for every evalu-
ated unit. Wober (2007) also underlined that DEA needs no a priori information
regarding which inputs and outputs are the most important in the evaluation
procedure. This gives possibility to use it for analysis for complex and often un-
known nature of relationships between variables. The model implies that inputs
and outputs are measurable, and infinitely divisible. DEA does not take into ac-
count qualitative information and some crucial factors affecting efficiency could
be not included into analysis. Therefore, careful interpretation and sensitivity
analysis is required. DEA can be a useful and powerful method of analysis for
someone, who fully understands both its potential and its limitations (Molinero&
Woracker, 1996).
Moreover, correlation coefficient method was used to remove output data,
which can duplicate information. In the analysis, Pearson’s linear correlation
coefficient between variables was used (DeVolpi, 1991):

4. Empirical data and analysis

The aim of the study is to examine the relationship between innovation expend-
iture (input) and the innovation results achieved. In order to calculate this cor-
relation study was conducted using statistical and empirical methods. Statistica
10 and Excel Spreadsheet were used for calculations. The study was limited to
seven countries form CEE region and periods of research from 2008 to 2015.
Main method employed was Data Envelopment Analysis (DEA). The effective-
ness in DEA method is defined as the ratio of the weighted sum of the results
by the weighted sum of inputs. Performance is relative, because it is created in
relation to the entire group of objects.
The estimated effectiveness will indicate to what extent expenditure on inno-
vation affected efficiency in selected CEE countries. Selection of diagnostic
variables was carried out based on available statistical data. The nine output
indicators chosen for analysis are as follows. Eight of them were sourced from
the Eurostat database and one comes from the World Bank. First, Research

491
 and development expenditure as a percentage of GDP (RDE), second Euro-
pean Union trade mark as a applications per million population (EUTM), the
third one is high-technology exports as a percentage of manufactured exports,
than Employment in high- and medium-high technology manufacturing sectors
as a percentage of total employment, human resources in science and tech-
nology (HRST) as a percentage of active population, patent applications to
the European patent office (PA) by priority year for mln inhabitants, high-tech
patent applications to the European patent office (PA-HT) by priority year for
mln inhabitants, graduates in tertiary education, in science, math., computing,
engineering, manufacturing, construction, by sex - per 1000 of population aged
20-29, employment in knowledge-intensive service sectors as a percentage of
total employment, scientific and technical journal articles for mln inhabitants.
Inputs indicator are the annual public and private spending on innovation (as
% GDP) represented by RDE. Source of this data is Eurostat Database. Due
to the lack of available data some indicators are marked with “*”, where values
are calculated as average of prior and flowing period. The values of indicators
are presented in the table 1.

2008 RDE EUTM HTE ETH-M HRST PA PA - HT GTE ETH - S ATJA

Bulgaria 0,45 36,31 3,80* 4,20 31,40 2,48 0,51 9,60 27,20 313,45
Czech
1,24 43,60 14,10 10,20 37,10 20,27 2,42 15,20 29,70 384,44
Republic
Croatia 0,88 4,87 6,70 3,80 29,00 6,70 1,90 10,70 27,10 2469,66
Hungary 0,98 28,67 20,20 8,60 33,30 18,04 4,55 6,10 33,20 637,95
Poland 0,60 42,16 4,30 5,40 33,40 6,13 0,89 14,10 28,30 613,29
Romania 0,57 14,30 5,40 5,00 23,80 1,62 0,66 17,90 19,00 357,05
Slovakia 0,46 29,20 5,20 10,20 32,00 6,86 1,58 15,20 29,60 619,88

Table 1. Diagnostic data of inputs and outputs – Innovation 2008

Note: RDE - the annual public and private spending on innovation (as % GDP); EUTM – European Union trade
mark applications (per million population) ; HTE – exports of high-tech products (as% of exports); ETH-M –
Employment in high- and medium-high technology manufacturing sectors (% of total employment) ; HRST
- Human resources in science and technology (% of active population) ; PA – number of patent applications to
the European patent office by priority year (for mln inhabitants) ; PA – HT - High-tech patent applications to the
European patent office by priority year for mln inhabitants ; GTE – Graduates in tertiary education, in science,
math., computing, engineering, manufacturing, construction, by sex - per 1000 of population aged 20-29 ;
EHT-S - Employment in knowledge-intensive service sectors (% of total employment) ; ATJA - Scientific and
technical journal articles (for mln inhabitants).
Source: Author’s own study based on Eurostat and World Bank Data Base

Selected data was verified to remove indicators, which duplicate information

with Correlation coefficient method have been used. Information replicate var-
iables are highly correlated (correlation coefficient > 0.8, (p< 0.05)). To obtain
the accuracy of the model three of these variables were removed (HTE, PA,
HRST). This relationship is shown in the table 2.

492
   RDE EUTM HTE ETH-M HRST PA PA - HT GTE ETH - S ATJA
RDE 1,000
EUTM 0,090 1,000
HTE 0,784 0,143 1,000
ETH-M 0,400 0,459 0,554 1,000
HRST 0,510 0,778 0,462 0,612 1,000
PA 0,881 0,378 0,897 0,715 0,741 1,000
PA - HT 0,691 0,009 0,949 0,538 0,435 0,834 1,000
GTE -0,205 0,019 -0,498 0,115 -0,283 -0,305 -0,601 1,000
ETH - S 0,413 0,464 0,596 0,558 0,841 0,703 0,705 -0,642 1,000
ATJA 0,205 -0,701 -0,077 -0,390 -0,199 -0,079 0,124 -0,260 0,046 1,000
Table 2. Correlation coefficients - Innovation 2008
Source: Authors’ calculations

In DEA method, in oppose to the statistical methods, strong correlation is un-

welcome. Another assumption in DEA model is coincidence between the inputs
and outputs variable. For that reason, correlation coefficient between inputs
and outputs was verified. Output variables with positive correlation with input
variable can remain in the model. In analyzed case one output variables was
removed (GTE). Final set of features is presented in table 3.

2008 RDE EUTM ETH-M PA - HT ETH - S ATJA

Bulgaria 0,45 36,31 4,20 0,51 27,20 313,45
Czech
1,24 43,60 10,20 2,42 29,70 384,44
Republic
Croatia 0,88 4,87 3,80 1,90 27,10 2469,66
Hungary 0,98 28,67 8,60 4,55 33,20 637,95
Poland 0,60 42,16 5,40 0,89 28,30 613,29
Romania 0,57 14,30 5,00 0,66 19,00 357,05
Slovakia 0,46 29,20 10,20 1,58 29,60 619,88

Table 3. The final set of features inputs and outputs – Innovation in 2008
Source : Authors’ calculations

Based on described analysis, variables, which have fulfilled a condition of cor-

relation have been selected to the model. The final set of inputs and outputs are
presented in table 3. In next step all values were standardize by linear transfor-
mation. Goal of this process was to obtain values from 0 to 1.

493
 2008 RDE EUTM ETH-M PA - HT ETH - S ATJA
Bulgaria 0,36 0,83 0,41 0,11 0,82 0,13
Czech Republic 1,00 1,00 1,00 0,53 0,89 0,16
Croatia 0,71 0,11 0,37 0,42 0,82 1,00
Hungary 0,79 0,66 0,84 1,00 1,00 0,26
Poland 0,48 0,97 0,53 0,20 0,85 0,25
Romania 0,46 0,33 0,49 0,15 0,57 0,14
Slovakia 0,37 0,67 1,00 0,35 0,89 0,25
Table 4. Standardized set of variables – Innovation in 2008
Source: Authors’ calculations

Then variables were divided into stimulants and anti-stimulants. In DEA method
anti-stimulants must be converted using differential formula to stimulants. In
analyzed case, all the output variables are stimulants. Finally, effectiveness in-
dex was calculated with assumption that all outputs have the same weight. The
obtained index reaches values from zero to one, where 1 represents exemplary
efficiency. The results of these calculations have been collected in table 5.

2008 RDE EUTM ETH-M PA - HT ETH - S ATJA Effectiveness technical

efficiency
Bulgaria 0,36 0,83 0,41 0,11 0,82 0,13 1,27 0,74
Czech 1,00 1,00 1,00 0,53 0,89 0,16 0,72 0,42
Republic
Croatia 0,71 0,11 0,37 0,42 0,82 1,00 0,77 0,45
Hungary 0,79 0,66 0,84 1,00 1,00 0,26 0,95 0,56
Poland 0,48 0,97 0,53 0,20 0,85 0,25 1,15 0,68
Romania 0,46 0,33 0,49 0,15 0,57 0,14 0,73 0,43
Slovakia 0,37 0,67 1,00 0,35 0,89 0,25 1,70 1,00
Table 5. The effectiveness of spending on innovation in 2008
Source: Authors’ calculations

494
 2008 technical efficiency
Slovakia 1,00
Bulgaria 0,74
Poland 0,68
Hungary 0,56
Croatia 0,45
Romania 0,43
Czech Republic 0,42
Average effectiveness 0,61
Table 6. Indication of the relative effectiveness of spending on innovation in 2008
Source: Authors’ calculations

The average efficiency for the country is 0.61. The leaders of the ranking are:
Slovakia, Bulgaria and Poland. In contrast, significantly below the average were
countries such as the Czech Republic, Romania and Croatia (see table 6).
To expand the analysis, the author assessed the effectiveness of spending on
innovation for an additional seven years (2009-2015). Diagnostic data of inputs
and outputs for these years are presented below in tables.

Relative effectiveness index 2008 2009 2010 2011 2012 2013 2014 2015
Bulgaria 0,74 0,75 0,84 0,88 1,00 0,89 0,71 0,66
Czech Republic 0,42 0,41 0,56 0,47 0,52 0,48 0,38 0,44
Croatia 0,45 0,46 0,72 0,69 0,85 0,59 0,59 0,67
Hungary 0,56 0,48 0,72 0,64 0,73 0,65 0,56 0,59
Poland 0,68 0,67 0,82 0,72 0,76 0,85 0,71 0,81
Romania 0,43 0,63 0,80 0,77 0,92 1,00 1,00 1,00
Slovakia 1,00 1,00 1,00 1,00 1,00 0,88 0,70 0,62
Table 7. Effectiveness expenditure on innovation in G8 countries in 2008-2015
Source: Authors’ calculations

Relative effectiveness
2008-2015
index
Slovakia 0,90
Romania 0,82
Bulgaria 0,81
Poland 0,75
Croatia 0,63
Hungary 0,62
Czech Republic 0,46
Average effectiveness 0,71
Table 8. Average effectiveness index for CEE countries in 2008-2015
Source: Authors’ calculations

495
 It may be noticed that the average efficiency for the country is 0.71 (see table
8). The leaders of the ranking are: Slovakia, Romania and Bulgaria. In contrast,
considerably below the average were countries such as Czech Republic, Hun-
gary and Croatia.

5. Results and discussion

The conducted analysis allowed calculating effectiveness indicators for seven
economies from CEE region: Bulgaria, Czech Republic, Croatia, Hungary, Po-
land, Romania and Slovakia. Research period covered eight years from 2008 to
2015. In addition, average effectiveness indicator was calculated and change in
indicator between 2015 and 2008. Table 9 shows the final effectiveness index.

Relative
2015-2008
effectiveness 2008 2009 2010 2011 2012 2013 2014 2015 Average
change
index
Bulgaria 0,74 0,75 0,84 0,88 1,00 0,89 0,71 0,66 0,81 -0,09
Czech
0,42 0,41 0,56 0,47 0,52 0,48 0,38 0,44 0,46 0,02
Republic
Croatia 0,45 0,46 0,72 0,69 0,85 0,59 0,59 0,67 0,63 0,22
Hungary 0,56 0,48 0,72 0,64 0,73 0,65 0,56 0,59 0,62 0,03
Poland 0,68 0,67 0,82 0,72 0,76 0,85 0,71 0,81 0,75 0,13
Romania 0,43 0,63 0,80 0,77 0,92 1,00 1,00 1,00 0,82 0,57
Slovakia 1,00 1,00 1,00 1,00 1,00 0,88 0,70 0,62 0,90 -0,38
Table 9. Effectiveness expenditure on innovation, average effectiveness index and change
in CEE countries in 2008-2015
Source: Authors’ calculations

According to obtained results money invested in innovation has been used in

the most efficient way in Slovakia during period 2008-2012 and in Romania
in years 2013-2015. Overall Slovakia is the most efficient according to DEA
methodology. Although Slovakia is not an innovative leader in CEE region, the
analysis proved that this economy is characterized by the most favorable ra-
tio of expenditures to outputs. The second in ranking is Romania (0.82) and
third Bulgaria (0.81). Poland obtained the average efficiency index with value
of 0.75, which is above average for studied countries. Croatia and Hungary
are below average for CEE countries, with results 0.63 and 0.62. The worst
efficiency index was obtained by the Czech Republic. Position of the Czech
Republic may be surprising, because it is seen as the most innovative country
in the CEE region; however, it has the highest R&D spending. As demonstrated
by quantitative research, huge innovation spending funds does not produce
proportionally large results. In all surveyed years, the Czech Republic recorded
the results of innovation spending efficiency below the average for all seven
countries. In conclusion it is worth noting, that DEA method is calculating tech-
nical efficiency, which examines the degree to which R&D expenditures have
been transformed into potential of innovation.
496
As input indicator has significantly different values for the studied countries
(from 0.45 to 1.97% GDP), and it has huge impact for the efficiency indicator.
Spending on R&D for studied countries is much below the EU28 average,
which is approximately 2% of GDP. The highest spending during research peri-
od was noted in the Czech Republic with average value 1.63% GDP, reaching
1.9% of GDP in 2013-2015. Slovakia is spending on R&D 1.2% of GDP. The
lowest R&D expenditures were noted in Romania with average for period 2008-
2016 0.46% of GDP and Bulgaria with average 0.64% of GDP. Poland and
Croatia are spending on average 0.8% of GDP.
Outputs indicators are presented as comparable data, e.g. divided by million
inhabitants or percentage. The Czech Republic is achieving the best results for
such output indicators as European Union trade mark (EUTM) applications per
million population, employment in high- and medium-high technology manu-
facturing sectors (% of total employment), patent applications to the European
patent office (EPO) by priority year for mln inhabitants. Poland has the biggest
share of human resources in science and technology (HRST) in active popula-
tion. The highest share of high-technology exports (% of manufactured exports)
is in Hungary. Also, Hungary is leading in high-tech patent applications to the
European patent office (EPO) by priority year for mln inhabitants and employ-
ment in knowledge-intensive service sectors (% of total employment). Howev-
er, tt can be concluded that countries, which are achieving the best innovation
results has the worst effectiveness results.
It is interesting to notice, that Romania made the most significant improvement
in efficiency indicator – from the one of the less efficient country in 2008 to the
most efficient in 2015. During period 2008-2015 R&D spending measured as
GDP percentage didn’t change much, but in the same time all outputs indica-
tors chosen for the DEA model increased. Croatia also improved innovation
efficiency, without significant change in R&D spending or even decrease, it
improved efficiency indicator. Slovakia, which is efficiency leader in years 2008-
2012, lost its position due to increase in R&D spending without proportional
increase in output indicators.
Undoubtedly, innovation means different things depending on where a coun-
try stands in terms of development. Overall, significant national and region-
al disparities exist in the innovative environment in Europe. Northern and
north-western European countries are performing strongly compared with a
lagging southern Europe and Central and Eastern Europe. According to the
European Innovation Index (European Commission, 2017) Romania and Bul-
garia are classified as modest innovators, while all other studied countries are
classified as moderate innovators. The Czech Republic is leader of moderate
innovators group and in next years can join strong innovators group. There-
fore, improvements in innovation in the Czech Republic are very different from
those relevant for Romania or Bulgaria. Innovation leaders can take advantage
related to commercialization of emerging technologies and spreading innova-
tion across regional or global markets. Countries less technologically advanced

497
should focus on catch-up strategies. The adoption of innovative technologies
and creating favourable conditions for the innovation development should be
key area of innovation strategies. Competitiveness and innovativeness divide
will require differentiated strategies, that take national and regional characteris-
tics into account. Investments in knowledge-generating assets will convert into
important drivers for future productivity growth.

6. Conclusions
Research on effectiveness of R&D spending expends current scientific knowl-
edge. The results of the research confirmed hypothesis, that higher R&D
spending is not causing proportional innovative effects for CEE economies.
DEA provides results for technical efficiency, which examines how public and
private expenditure have been converted into the effects. The efficiency indica-
tor informs about the effectiveness of the use of funds. Countries with the high-
est R&D spending have the highest innovative outputs, but funds were not used
efficiently. Moreover, author innovatively used DEA methodology, which is pop-
ular at the microeconomics-level research, but so far has not been implement-
ed to macroeconomic studies. It is worth to mention, that currently international
organizations are working on more sufficient innovation input statistics such as
stock of current knowledge, number of innovative enterprises, R&D expendi-
tures, human resources and research infrastructures, which can provide more
actual picture of effectiveness. Also, innovative outcomes are hard to present
in statistics. Launching a patent or new technology will cause additional eco-
nomic profits in the future. However, they are hard to estimate and time delay
should be also considering. Including such inputs and outputs into DEA mod-
el would provide better overview of effectiveness of innovative actions in the
economy. However, nowadays such statistics are not yet available. Author in
this research was imitated by available data, as countries comparative studies
require comparable and uniform statistics. Moreover, analysis of longer period
could bring more general conclusion and recommendations for innovative pol-
icies. Further research can be conducted for regions, as in each country there
are huge differences between regions in terms of innovation capabilities. Even
the EU is recently focusing more on regions, than countries. Competitiveness
of EU is assessed at regional level in European Regional Competitiveness In-
dex, where one of three dimensions is innovation. Area of research in this ar-
ticle covered only innovation factor. Analysing effectiveness of other types of
country spending may acquire a general efficiency indicator, which will allow
classifying countries according to their effectiveness level. Such analysis would
answer the question on which state policy is the most effectively using avail-
able resources. Finally, the results of this study can be used by policymakers
working on innovation policies in CEE countries. Research confirms that CEE
countries are not able to achieve innovation outputs proportional to the R&D
spending. For those countries where innovative capacities are still limited more
reasonable seems to be step by step policy. Gradual increase in investment in
innovation may produce better conditions for innovation-driven growth.

498
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Appendices

2008 RDE EUTM HTE ETH-M HRST PA PA - HT GTE ETH - S ATJA

Bulgaria 0,45 36,31 3,8* 4,20 31,40 2,48 0,51 9,60 27,20 313,45
Czech
1,24 43,60 14,10 10,20 37,10 20,27 2,42 15,20 29,70 384,44
Republic
Croatia 0,88 4,87 6,70 3,80 29,00 6,70 1,90 10,70 27,10 2469,66
Hungary 0,98 28,67 20,20 8,60 33,30 18,04 4,55 6,10 33,20 637,95
Poland 0,60 42,16 4,30 5,40 33,40 6,13 0,89 14,10 28,30 613,29
Romania 0,57 14,30 5,40 5,00 23,80 1,62 0,66 17,90 19,00 357,05
Slovakia 0,46 29,20 5,20 10,20 32,00 6,86 1,58 15,20 29,60 619,88

Table A1. Diagnostic data of inputs and outputs – Innovation 2008

Note: Due to the lack of available data introduced indicators marked “*”, which are values in the period
preceding, following or their average.
Source: Author’s own study based on Eurostat and World Bank Data Base

2009 RDE EUTM HTE ETH-M HRST PA PA - HT GTE ETH - S ATJA

Bulgaria 0,49 36,69 3,8* 3,60 31,80 2,12 0,45 10,80 28,00 341,77
Czech 1,29 46,52 15,20 9,50 37,90 16,89 1,47 15,60 30,80 423,02
Republic
Croatia 0,84 7,89 7,60 3,30 30,30 5,11 0,35 13,50 28,80 2598,17
Hungary 1,13 28,71 22,20 7,80 33,30 18,38 3,77 7,50 34,40 601,13
Poland 0,66 40,59 5,70 4,80 34,90 7,65 1,15 14,30 29,50 615,45
Romania 0,46 16,19 8,20 4,60 24,10 1,52 0,73 24,00 19,80 467,22
Slovakia 0,47 38,64 5,90 8,60 32,00 5,36 0,78 17,80 31,00 587,90

Table A2. Diagnostic data of inputs and outputs – innovation 2009

Source: Author’s own study based on Eurostat and World Bank Data Base

2010 RDE EUTM HTE ETH-M HRST PA PA - HT GTE ETH - S ATJA

Bulgaria 0,56 49,31 3,8* 3,30 32,10 2,29 0,07 12,10 28,90 350,20
Czech 1,34 61,94 16,10 9,50 37,80 18,41 1,50 16,90 31,80 422,59
Republic
Croatia 0,74 5,35 7,00 3,10 31,60 7,05 0,58 12,30 30,20 2945,45
Hungary 1,14 38,15 21,80 8,20 33,00 19,52 5,12 8,30 35,10 586,22
Poland 0,72 46,47 6,00 4,60 35,90 9,50 1,69 15,80 30,10 645,70
Romania 0,45 20,30 9,80 4,40 24,00 1,71 0,35 18,80 19,80 542,52
Slovakia 0,62 34,51 6,60 8,60 33,50 8,63 0,80 18,70 32,30 674,96

Table A3. Diagnostic data of inputs and outputs – innovation 2010

Source: Author’s own study based on Eurostat and World Bank Data Base

502
 2011 RDE EUTM HTE ETH-M HRST PA PA - HT GTE ETH - S ATJA
Bulgaria 0,53 58,76 3,8* 3,40 32,70 3,58 0,31 12,40 29,40 346,56
Czech
1,56 71,42 16,40 9,90 35,90 21,25 2,52 16,60 31,60 473,52
Republic
Croatia 0,75 10,96 5,80 3,80 29,80 3,96 0,16 14,9* 29,50 3157,37
Hungary 1,19 35,35 20,90 8,70 34,60 22,19 6,61 8,50 34,50 642,84
Poland 0,75 51,07 5,10 4,80 36,60 10,11 1,57 17,50 30,00 679,33
Romania 0,49 31,44 8,80 4,70 25,40 2,99 0,59 19,30 20,60 539,93
Slovakia 0,66 49,88 6,60 9,70 33,90 10,17 1,62 18,00 32,30 723,14

Table A4. Diagnostic data of inputs and outputs – innovation 2011

Source: Author’s own study based on Eurostat and World Bank Data Base

2012 RDE EUTM HTE ETH-M HRST PA PA - HT GTE ETH - S ATJA

Bulgaria 0,60 66,74 3,80 3,60 32,80 4,62 0,85 13,30 29,90 372,99
Czech
1,78 87,48 16,10 10,60 36,60 22,08 1,96 16,70 32,00 458,19
Republic
Croatia 0,75 9,59 7,20 3,80 31,50 4,53 0,12 17,40 30,80 3262,15
Hungary 1,26 35,04 17,30 8,40 35,60 20,92 5,35 9,50 35,10 661,56
Poland 0,88 56,54 6,00 4,90 37,70 12,70 1,57 17,90 30,60 738,63
Romania 0,48 28,36 6,30 4,50 25,50 3,56 0,79 18,70 20,40 550,44
Slovakia 0,80 51,26 8,20 10,20 32,50 8,24 1,40 17,90 31,90 788,61

Table A5. Diagnostic data of inputs and outputs – innovation 2012

Source: Author’s own study based on Eurostat and World Bank Data Base

2013 RDE EUTM HTE ETH-M HRST PA PA - HT GTE ETH - S ATJA

Bulgaria 0,63 63,56 3,85* 3,90 34,00 5,47 0,43 14,60 30,40 377,98
Czech
1,90 81,78 15,10 10,50 37,20 23,83 2,13 16,90 32,60 447,10
Republic
Croatia 0,81 29,33 7,90 3,60 34,50 4,34 0,77 15,50 32,80 3379,03
Hungary 1,39 47,43 16,30 8,50 36,00 21,76 4,30 11,20 36,10 652,75
Poland 0,87 71,86 6,70 5,00 39,00 14,38 2,31 19,2* 31,20 789,86
Romania 0,39 23,08 5,60 4,80 25,10 4,25 0,71 17,60 20,10 558,29
Slovakia 0,82 50,82 9,60 9,80 32,50 9,19 1,01 18,00 32,80 853,21

Table A6. Diagnostic data of inputs and outputs – innovation 2013

Source: Author’s own study based on Eurostat and World Bank Data Base

503
 2014 RDE EUTM HTE ETH-M HRST PA PA - HT GTE ETH - S ATJA
Bulgaria 0,79 92,05 3,90 3,70 35,40 6,55 0,426* 14,20 30,70 378,76
Czech
1,97 85,52 15,30 11,20 38,10 25,68 2,13* 16,60 32,60 425,57
Republic
Croatia 0,78 30,14 6,60 3,30 35,10 3,43 0,767* 15,70 33,50 3691,01
Hungary 1,35 53,86 14,50 8,90 36,30 22,51 4,302* 12,20 35,70 694,41
Poland 0,94 84,78 7,90 5,20 40,40 16,02 2,307* 20,50 31,40 835,91
Romania 0,38 29,58 6,40 5,30 25,60 5,11 0,711* 16,60 20,00 541,46
Slovakia 0,88 61,49 9,90 9,40 32,90 9,19 1,007* 17,20 34,00 948,29

Table A7. Diagnostic data of inputs and outputs – innovation 2014

Source: Author’s own study based on Eurostat and World Bank Data Base

2015 RDE EUTM HTE ETH-M HRST PA PA - HT GTE ETH - S ATJA

Bulgaria 0,96 90,53 4,60 3,90 36,30 6,55* 0,43* 14,60 31,20 361,74
Czech
1,93 94,13 15,40 11,20 38,10 25,68* 2,13* 17,20 32,00 417,35
Republic
Croatia 0,84 31,24 7,10 3,20 36,20 3,43* 0,77* 16,80 33,50 3993,41
Hungary 1,36 57,33 15,20 9,10 36,70 22,51* 4,3* 12,20 35,90 666,25
Poland 1,00 96,38 8,50 5,30 41,60 16,02* 2,31* 21,40 31,20 862,15
Romania 0,49 32,71 7,30 5,60 27,00 5,11* 0,71* 14,90 21,80 580,12
Slovakia 1,18 66,96 9,80 10,60 33,50 9,19* 1,01* 16,60 33,80 960,22

Table A8. Diagnostic data of inputs and outputs – innovation 2015

Source: Author’s own study based on Eurostat and World Bank Data Base

504
 PART 8

DIGITAL MARKETING
 CHAPTER 29

Customer Preferences towards Digital Marketing Strategies

Jelena Sormaz1, Marija Kuzmanovic2, Veljko Jeremic3

ABSTRACT

The aim of this paper is to determine customer preferences towards different strategies
of Digital Marketing used to promote sale of electronic devices (laptops, tablets etc.).
The interest in this type of products is expected to increase in the future, therefore it is
essential for companies to find the best way to stand out from the competition. In the last
decade, the development of modern technology has made Digital Marketing the most
important way of interaction between companies and their customers. Digital Marketing
tools give broad range of opportunities for companies to attract and retain consumers,
but they need to know how their customers evaluate their marketing efforts. In order
to examine which marketing strategies consumers prefer, in this paper we use Choice
Based Conjoint Analysis (CBC). This method asks the respondents to choose between
different combinations of marketing elements, which represents typical choice making
problem they face in everyday life. Also, CBC gives us the opportunity to analyse po-
tential interactions between given elements. Knowing which combination is seen as the
most preferred one could help companies to allocate their resources and create market-
ing strategies that will ensure positive effects on their business performance.

Key words: customer preferences, Digital Marketing, Choice Based Conjoint

Analysis

JEL classification: C19, M31

1. Introduction
Almost twenty years ago it became clear that it is not the question whether the
Internet should be used for marketing purposes, but how it should be done
(Subramaniam et al., 2000). Modern consumers want the marketing process to
be more interactive, and to give them the possibility to be more engaged (Ryan
and Jones, 2009). The Internet brought fundamental changes, affecting the
marketing flows and activities, and inducing/initiating the emergence of Digital

1 PhD student, University of Belgrade, Faculty of Organizational Sciences, Jove Ilica 154, 11000
Belgrade, Serbia. Scientific affiliation: quantitative management. Phone: +381 64 32 868 33.
E-mail: jelenasormaz91@gmail.com.
2 Associate Professor, University of Belgrade, Faculty of Organizational Sciences, Jove Ilica 154,
11000 Belgrade, Serbia. Phone: +381 11 3950 800. E-mail: kuzmanovic.marija@fon.bg.ac.rs.
3 Associate Professor, University of Belgrade, Faculty of Organizational Sciences, Jove Ilica 154,
11000 Belgrade, Serbia. Phone: +381 11 3950 800. E-mail: jeremic.veljko@fon.bg.ac.rs.

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Marketing (Subramaniam et al., 2000). This concept brings numerous chal-
lenges and opportunities, as well as a significant degree of uncertainty among
managers considering the allocation of effort and budget to different elements
of Digital Marketing. Each year the investment in Digital Marketing increase, so
it is highly important to explore this field and to allocate the budget based on the
research findings to ensure success and effectiveness on created strategies.
There are various elements that could be included in the Digital Marketing strat-
egy. We decided to focus on four, which we consider essential for attraction of
new customers. Those are website, social media, blog and mobile marketing.
The experts, such as Gartner (2015), are forecasting the increase of demand of
electronic devices, and they expect the intensification of competition in this in-
dustry. Pre-purchase information search is a critical step in the buying process
(Mourali et al., 2005), especially when purchasing durable products (Malhotra,
1986), such as electronic devices. This brings the need to thoroughly examine
the effect of Digital Marketing on consumers’ choices of this type of products.
Another source of turbulences on modern markets are the emergence and
growing influence of Generations Y and Z (Tapscott, 2009), who differ to a
great extent from the previous generations. This is why the focus of this paper
is on the student population, whose preferences and habits in the digital world
we try to examine. Since marketing is customer-centered, the understanding of
customers’ needs and preferences is the key for creating successful and effec-
tive marketing strategy. It is essential to know how to approach these new gen-
erations, as well as to consider the ways they are influencing the world around
them, with their attitudes, values and habits, to grab their attention and earn
their trust, and answer their demands. We presume that younger generation
relies on the modern technologies when deciding about their purchases. This
paper tends to provide useful insight into the way they perceive and evaluate
different strategies of Digital Marketing. In order to discover their preferences
towards these strategies, we applied Choice Based Conjoint analysis (CBC)
(Louviere and Woodworth, 1983). This method has become popular in the mar-
keting research community over a decade ago (Struhl, 1994), and nowadays is
also frequently used in healthcare, environmental, government and non-profit
sectors. It helps us to understand how people make choices and what they
value the most in the tested concepts (in this case, marketing strategy). When
answering to the CBC questions, the respondent is asked to choose the most
preferred alternative of all the offered (Helme and Kallio, 2011), simulating that
way the real-life purchase decisions (choices), which represents realistic and
relatively simple task for them (Desarbo et al., 1995). Our respondents will be
asked to choose between several strategies the one that they consider to be
the most helpful to them when making a purchasing decision. Results of CBC
analysis will help us discover the most important element of digital strategy, as
well as the most preferred combination of elements that can be further shaped
and implemented as a part of marketing mix.

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The paper is organized as follows. Section 2 provides the literature review of
key points of the paper. Section 3 presents the CBC analysis. Section 4 gives
an insight into the design of the conducted survey and the obtained results.
Section 5 offers the discussion on practical implications of the main findings.
Section 6 provides some concluding remarks, points out several limitations of
this paper and offers recommendations for further research.

2. Literature Review
The Digital Marketing Institute gave the following definition of Digital Market-
ing: “it is the use of digital technologies to create an integrated, targeted and
measurable communication which helps to acquire and retain customers while
building deeper relationships with them” (Smith, 2007, in Wymbs, 2011, p. 94).
It includes promotion and education of consumers about product, services, and
brands using a variety of online media (Williams et al., 2012). The focus of mar-
keting has been moved from company to the customer, and now Digital Market-
ing is customer-centric, user-generated, interactive and dynamic, encouraging
community participation (Singh et al., 2008). Marketing in the digital age has
been transformed and now the interaction between companies and consum-
ers mostly happens in form of dialogue, moving the emphasis from telling to
listening (Ryan and Jones, 2009). Customers nowadays represent proactive
audience, they are more in control of their exposition to marketing efforts (Singh
et al., 2008), they have the possibility to choose, as well as to create marketing
content (Iosub et al, 2016). The features of virtual environment, such as extend-
ed reach, enhanced interactivity, increased speed, and higher flexibility, ena-
bled two-way communication, richer interaction and enlarged size and scope of
the audience (Subramaniam et al., 2000; Stewart and Pavlou 2002; Sawhney
et al., 2005). Digital Thanks to its capacity to to both broaden the scope of the
marketing reach and narrow its focus at the same time (Ryan and Jones, 2009),
Digital Marketing enables marketers to target smaller segments of consumers
with specified interests or purchase behavior. Digital Marketing is based on
more innovative and cost-effective communication channels, providing custom-
ers with high interactivity and individualisation, which were not possible with
traditional communication platforms (Joshi, 2013; Leeflang et al., 2014).
Website is one of the key elements of Digital Marketing strategy. Its main pur-
pose is to provide information to its users (Angehrn, 1997). Companies should
base its design and content on business goals and the needs of target market,
with the emphasis on its usability and accessibility, in order to ensure its ef-
fectiveness (Ryan and Jones, 2009). They need to choose wisely verbal and
nonverbal elements and the way to present them, since they are influencing
the extent of attention that customers will pay to the message company tries to
transmit via its website.
Social media is one of the key factors in the process of transformation of con-
sumer behaviour (Kaplan and Haenlein, 2010). It now represents one of the

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main sources of information for customers who and turning more frequently
to various types of social media to conduct their information searches and to
make their purchasing decisions (Lempert, 2006; Vollmer and Precourt, 2008).
They perceive it as a more trustworthy source of information, compared to the
corporate-sponsored communications transmitted via the traditional elements
of the promotion mix (Foux, 2006). By using social media, companies can ap-
proach their customers in a more natural and informal manner, presenting them
real information (Christodoulides, 2009; Weinberg and Pehlivan, 2011), and au-
thentic stories about their brand (Fournier and Avery, 2011). In addition, social
media activities help companies to avoid misunderstandings and prejudices
(Kim and Ko, 2012). Social media has become an important part of an organi-
zation’s marketing communications (Bruhn et al., 2012), as a successful tool for
engaging customers and building unique customer relationships (Taiminenet
and Karjaluoto, 2015). It facilitates the interaction with customers, information
search, interactivity, promotion and enhancement of customers buying behav-
iours (Zeng and Gerritsen, 2014). 2017 Social Media Marketing Industry Report
provided an important insight into the social media usage in marketing purpos-
es. The research has shown that Facebook, Twitter, LinkedIn, and Instagram
were the top four platforms used by marketers, who confirmed that social media
is important to their businesses. They perceived increasing exposure and in-
creasing traffic as the top two benefits of social media marketing.
Many companies use blogging as it represents a good relationship tool for both
marketing and PR (Ahuja and Medury, 2010; Cho and Huh, 2010), and pro-
vides a real time insight on customers’ opinions about company’s products, as
well as on the opinions about competition. The interactivity that is characteristic
for blogs enables building closer relations with the customer, which facilitates
managing those relations, and helps improving media relations, and testing
new ideas for products and services (Singh et al., 2008).
Within digital, mobile is the fastest growing medium (Smith, 2017), whose de-
velopment is causing a second Internet revolution, which is even more inten-
sive than the first one (Husson et al., 2013). The widespread adoption of mobile
phones represents a great marketing opportunity for companies to reach and
serve consumers anytime, anywhere (Grant and O’Donohoe, 2007; Roach,
2009; Barutçu, 2007). The potential of smartphones in the shopping is on its
growing trajectory, and it is the key element for a personalised shopping expe-
rience, which is one of the most significant trends in retail. Smartphones and
mobile devices are facilitating real-time, location-based communications, and
quick access to information on the consumer’s timetable (Smith, 2017).
When building a Digital Marketing strategy, it is crucial to understand people,
the way they are using modern technology, and how the companies can use it
to engage with them more effectively. The essence is how the marketing can
enhance their shopping experience and help them to make more informed deci-
sions (Ryan and Jones, 2009). It is important to have in mind that Digital Market-
ing is not just a faster or newer channel within traditional marketing, but rather

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a new approach to marketing, that brings fundamental changes of the concept
of marketing (Wind and Mahajan, 2002). One of the tasks of Digital Marketing
is finding the best way to communicate with customers, to meet their changing
needs, and to build sustainable relationships and loyalty (Wymbs, 2011). How-
ever, when using modern technologies in marketing purposes, companies can
be perceived as intruders, especially if they do not respect the norms assumed
by its users (Fournier and Avery, 2011; Persaud and Azhar, 2012). Companies
should make an effort to determine and understand their consumers’ preferenc-
es, why and how consumers may want to participate in Digital Marketing and to
adapt their strategies to their customers’ wishes and needs.
Growing purchasing power (Wolburg and Pokrywczynski, 2001), along with
the influence on other’s buying decisions (Horovitz, 2002) makes members
of generations Y and Z important players in the modern markets. Generation
Y, or “the Millennials” (Kultalahtii and Viitala, 2015), was born between ear-
ly 1980s and approximately 1995 (Parry and Urwin, 2011; Lyon et al., 2010;
Hays, 2013), while Generation Z, “digital natives” (Prensky, 2001; Friedrich
et al., 2010) was born after 1995 (Seemiller and Grace, 2016; Koulopoulos
and Keldsen, 2016). What makes the key difference between them is the way
they relate to technology (Easton, 2016). While members of Generation Y are
known as tech savvy (Bannon et al., 2011; Beekman, 2011; Cekada, 2012),
the members of Generation Z are true digital natives (Friedrich et al., 2010).
Characteristics such as visual sophistication (Williams et al., 2012), short at-
tention span (Elmore, 2014), and the ability of multitasking (Kilber et al., 2014),
are inherent to both generations. However, since most of these features have
emerged as a consequence of rapid and intensive technology development
(Smith, 2017; Bannon et al., 2011), they are more emphasised in the Genera-
tion Z. Moreover, the research has shown other differences related to buying
behavior in the digital world. Bannon et al. (2011) suggest that Generation Y is
more liberal with sharing private information online and it is more comfortable
building relationships online, while members of Generation Z value more their
privacy online. Also, Generation Z is considered to be more pragmatic, more
money conscious, less focused compared to Generation Y (Williams, 2015;
McGorry and McGorry, 2017).
Nevertheless, to both generations, digital tools are indispensable, utterly in-
tegrated elements of their lives (Ryan and Jones, 2009). They always consult
the Internet before making a purchase, they scrutinize a product, its features,
and its price, before going to a store. For these generations, especially the
generation Z, it is a social norm to be constantly connected with not only their
friends and family but also brands and businesses (Fromm, 2016). As con-
sumers, they want to be “prosumers”, i.e. to co-innovate products and services
with producers. They are not just passive observers, they want to participate
(Tapscott, 2009). According to Elmore (2010), these two generations differ to
a great extent from previous generations especially when it comes to the use
of cell phones. The smartphone is not just a tool, but also a source of social

511
connection, entertainment, and information. A recent survey conducted among
Generation Y showed that 83% of them were keeping their mobile phones
close at all times (Bannon, et al., 2011). Moreover, the majority of Digital Na-
tives use their phones to conduct online shopping (MarketingCharts, 2017),
to search for product information and for suggestions on what products they
might like (Smith, 2017). Therefore, marketers should design campaigns that
take advantage of young peoples’ constant connectivity to technology, their
multi-tasking behaviors, and the fluidity of their media experiences (Montgom-
ery and Chester, 2009). Having constant access to technology, they are more
visually literate than previous generations (Stanford and Reeves, 2007), and,
therefore, more comfortable with images and graphics than with text (Palfrey
and Gasser, 2008). They often even refuse to read a lot of text (Cekada, 2012).
Consequently, video might be the crucial format for this audience. SnapChat
and Instagram are good examples with their brief videos, showing that com-
panies have to communicate the most important information directed to these
consumers in a short period of time (McGorry and McGorry, 2017).
It is hard to impress consumers who belong to these two generations, since
they have been constantly exposed to various marketing campaigns on a daily
basis. That could be one of the reasons why they appreciate a more engaging
and subtle approach (Misonzhnik, 2009), done in a way that they do not feel as
the obvious targets of marketing efforts (Castronovo and Huang, 2012). They
prefer those forms of marketing that gives them the freedom and resources
to encounter the brand by themselves, instead of being dictated to. Marketing
efforts should be aimed at creating subtle, but effective approach that would
make them curious about a product or service that they intend to purchase in
the future (Yi, 2014).

3. Methodology
The key part of the research is the application of Choice Based Conjoint anal-
ysis (CBC), with the aim to determine students’ preferences towards different
strategies of Digital Marketing. Wickliffe and Psyarchik (2001) claim that con-
sumers choose products based on their attributes that they find valuable and
that provide them certain benefits. Each attribute has a different importance for
the consumer, but when observing a certain product, he perceives the sum of
their interaction. Puth et al. (1999) have shown that customers use the attrib-
utes to compare the products and make their purchasing decisions. Meghani
et al. (2013) confirm this point of view claiming that the utility or desirability of
any entity can be described based on the value of its separate, yet, conjoined
parts. The base of conjoint analysis is breaking a product or service down into
its components (attributes and levels) and then testing combinations of these
components in order to find out what customers prefer. Rather than directly
asking respondents what they like in a product (service, or any tested concept),
or what features they find most important, conjoint analysis faces the respond-

512
ents with the more realistic task. They are asked to choose one of the alterna-
tives from the choice set. Each alternative represents different combination of
levels of multiple attributes. The respondent repeats this task for a limited num-
ber of choice sets, providing repeated choice data. Then, these choices are
converted to utilities (attribute importance scores, level values, or partworths)
for each of the levels of the individual attributes (Louviere et al., 2000; Louviere
and Woodworth, 1983). Partworth utilities are numerical scores that measure
how much each attribute influences the customer’s choice, i.e. they represent
the value of each component of the tested concept in terms of its effect on cus-
tomer decisions. Apart from attribute partworths, it is also possible to calculate
level partworths, which enables deeper understanding of the effect of specific
features within an attribute on customers’ choice.
A choice-based conjoint analysis questionnaire consists of Q questions, gen-
erated using some efficient design principle such as fractional factorial design.
When a choice-based conjoint question includes A profiles, defined by attrib-
ute levels, and the respondent chooses the most preferred one, we know that
the chosen alternative is preferred to each non-chosen alternative. For each
respondent our information on the utilities employed for estimation consists of
preference inequalities, the number of which is n = Q (A – 1). For each pair-wise
comparison the utility margin is the utility difference between the chosen and
the not-chosen alternative. Such a margin is non-negative for a consistent utility
function (Halme and Kallio, 2011).
Conjoint.ly estimates a hierarchical bayesian (HB) multinomial logit model of
choice using valid responses. The value (partworth) of each level reflects how
strongly that level affects the respondent’s purchasing decision. Attribute im-
portance and level value scores (partworth utilities) are calculated by taking
coefficients from the estimated model and linearly transforming them so that:
• in each attribute, the sum of absolute values of positive partworths equals
the sum of absolute values of the negative ones, and
• in each attribute, the sum of the spreads (maximum minus minimum) of
parthworths equals 100%.
CBC analysis enables us to track changes of consumers’ choices, which rep-
resent their reactions to a series of changes in attribute levels of an observed
(Meghani et al., 2013). The main advantage of CBC is that it provides full-profile
in the questions, i.e., all the attributes are presented to the respondent at one
time, allowing respondents to make trade-offs between attribute levels, as they
do when making decisions in the real life (Orme, 2010). Also, this method al-
lows us to discover the possible interactions between certain levels of different
attributes. These interactions represent the case when the net utility effect of
levels from two separate attributes is significantly higher or lower than what
would be predicted by summing their main effect parts. Knowing the effect that
certain combinations have on consumers’ choice could be crucial for under-
standing the process of making their purchase decisions.

513
4. Empirical Data and Analysis
The research was based on the survey that was conducted in February 2018
among students of second year of Faculty of Organizational Sciences, Uni-
versity of Belgrade. The survey had three parts – first two questions referred
to their demographic characteristics, after which followed the set of ten CBC
questions, and the third part provided information on their experiences, prefer-
ences and habits in the digital world. Each Conjoint question consisted of three
profiles (alternatives) – combinations of attribute levels, and the ‘’none of the
above’’ option. The attributes and their levels were the following:
1. Information provided on website
a. Detailed specification and photos of products
b. Basic information on the offer and the way of purchase
c. No website

2. Presence on social media

a. Present
b. Not present

3. Existence of blog
a. Exists
b. Does not exist

4. Mobile application
a. Possibility to order
b. Information on current offer
c. No application

The experimental design, which consisted of the process of assembly of levels

into concepts and then into choice sets, was automated by Conjoint.ly, optimis-
ing balance and overlap. When the data had been collected, CBC analysis was
performed by Conjoint.ly. Apart from CBC, come classical statistical analysis
was conducted. Descriptive analysis and statistical testing were performed us-
ing SPSS (IBM SPSS Statistics 20).
In the survey participated 572 respondents, 61% of them were female, and
39% male. The average age of respondents was 20.78 years, with youngest
respondent having 19, and the oldest 26 years. The majority of our respondents
are the members of Generation Z, and only 7.5% of them belong to the Gener-
ation Y. Almost all of them possess a mobile phone (99.5%) and a majority has
a laptop (63.5%), while PC is more popular with male students – 74.4% males

514
compared to 56.5% females have a PC. Tablets are somewhat less popular,
30.9% of students possess one. When it comes to the brand of mobile phone,
students prefer Samsung (37.2%), followed by Apple (26.9%) and Huawei
(18.4%). The importance of mobile phones in young people everyday life con-
firms the fact that 80.8% of respondents claim that they access Internet mostly
via this device, and more than 84% of students are always online, while 15.6%
of them use Internet only when they have the possibility to use Wi-Fi. This is not
surprising, having in mind similar research (Chaffey, 2016; Villanti et al., 2017).
When it comes to the popularity of social networks, it is not unexpected to see
that only 3.3% of respondents do not use any social network. Facebook is still
the most popular among students, (86.7% of them use it actively – visit and
post content at least two to three times a week), followed by Instagram (81.6%
are active users). Popularity of other social networks can be seen in the follow-
ing graph (Figure 1).

Figure 1. Popularity of social networks between male and female students

Students use social networks mostly to communicate with their friends (85.5%)
and search for information (72.2%). Slightly less they tend to use them for
entertainment (58.2%), and this approach to social media is somewhat more
characteristic for male students, although this difference was not proven to be
statistically significant (p>0.05).
When it comes to purchasing goods online, students mostly buy clothes and
shoes, and technical and electronic devices. However, almost 24% of respond-
ents do not perform Internet purchase. When deciding about purchase of an
electronic device (laptop, tablet etc.), students rely mostly on their previous
experiences. The next source of information for making this decision is the
Internet, which is slightly more important for male students. Female students
are more prone to relying on the friend’s advice than male students are. The

515
least significant help was expected from the shop assistant in the store. Results
show that students consider performance and price as the most important fea-
tures of electronic devices, having the strongest influence on their purchase.
Mann-Whitney test has shown that the brand and design are more important
to female students, and Kruskal-Wallis test has proven that students who were
ready to pay more for their current mobile phone also pay more attention to
these characteristics (p<0.05). Also, the frequency of buying a new mobile
phone has shown to have somewhat significant positive correlation (rs=0.087,
p<0.05) with the perception of brand as significant for making a purchasing
decision.
The CBC analysis has shown that the website is the most important element of
Digital Marketing strategy for our respondents, while blog has the least impor-
tance (Figure 2). The level partworths are presented in the Figure 3. Levels that
are strongly preferred by customers are assigned higher scores, while levels
that perform poorly (in comparison) are assigned lower scores. The chart is
scaled so that, for each attribute, the sum of all positive values equals the sum
of all negative values. The results suggest that the respondents showed the
strongest negative preference in case when the company did not have a web-
site, while the website with detailed specification and photos of products was
perceived as a most preferred feature of Digital Marketing strategy. Presence
on social media and existence of mobile application are also considered useful,
but not to the extent expected when looking into previous research (Powers et
al., 2012; Hamilton et al., 2016). The possibility to order a product using mobile
application is seen as a useful, but not the key element. Moreover, although
previous research suggested that the customers thought more positively about
companies that had blogs (Kim and Ko, 2010), our respondents were rather
indifferent towards its existence.

Figure 2. Relative importance score

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Figure 3. Relative value score

Conjoint.ly also provided a rank list of all possible level combinations based on
respondents’ preference (Table 1). For each concept was calculated the sum
of partworth utility scores of all attribute levels that comprise the concept, rep-
resenting the value each concept has to customers. The rank was determined
based on these sums.

Social Mobile
Rank Website Blog
Media application
Detailed specification and photos Information on
1 Present Exists
of products current offer
Detailed specification and photos Possibility to
2 Present Exists
of products order
Detailed specification and photos Does not Information on
3 Present
of products exist current offer
…
Does not
34 No website Present No application
exist
Not
35 No website Exists No application
present
Not Does not
36 No website No application
present exist

Table 1. Top 3 and bottom 3 digital marketing strategies based on respondents’

preferences

The best ranked is the strategy that assures the presence on all named chan-
nels and provides the most detailed information. As expected, the least preferred
strategy is the one without any of suggested elements of Digital Marketing.

517
5. Results and Discussion
The results of this paper confirm that Digital Marketing is highly important to the
young generations. Companies that are not present on the Internet might lose
a significant number of potential customers, who rely mostly on the information
they can find online when deciding about their purchase. Although they do not
tend to purchase goods online frequently, students use Internet as an important
source of information. After their own previous experiences, the Internet is the
next thing they rely on. CBC results suggest that when choosing an electronic
device, students start their online research with the company’s website. They
expect to find there all the relevant information, as well as the pictures of the
offered products. Since the results suggest that website is the inevitable part of
pre-purchasing process, companies need to work on its design and content in
order to attract and retain customers’ attention. Wind and Mahajan (2002) claim
that captivating and engaging design, along with relevant content, ensure that
customers spend time on the site and develop relationships with the company.
Furthermore, since social networks represent important part of everyday life,
companies should try to use them to approach their customers. This confirms
the findings of previous research (Gangadharbatla, 2008; Jones et al., 2009;
Weigand, 2009). The results show that students use Facebook and Instagram
the most, so these are the networks companies should pay the most attention
to. Mobile application is another element that should be included into the strat-
egy. Marchetti (2016) claims that mobile advertising is nowadays imperative for
reaching the younger generation. When creating the application, special care
should be taken to ensure its functionality (Smith, 2017). Customers expect
its use to be fast and unobstructed, that it is easy to navigate, and that it gives
them the possibility to control the content they want to access, as well as the
time when they want to do it. On the other hand, we could see that one of the
best ranked strategies does not include blog. Considering the indifference re-
spondents expressed towards this element, it might not be worth investing in.
Our respondents appreciate the presence of company on different channels,
which confirms the results of previous research. Lella and Lipsman (2016)
claim that the majority of consumers are ‘‘multi-screening’’, i.e. using multiple
devices to access the Internet. Furthermore, Smith (2017) suggests that com-
panies need to create multi-channel marketing strategies that can be viewed on
different types of devices.
Although there have not been detected significant differences between male
and female students, Digital Marketing enables companies to mold their strate-
gies, to adapt them the slightest differences between consumers. In that sense,
the strategies that would suite better to male students could be directed to-
wards creation of mobile application with entertaining content, providing all the
necessary information of products’ features. Also, since they are more prone
to purchasing electronic devices online, the application should enable them
to make an order. Female students could, however, be more in favor of the

518
strategies that rely on word-of-mouth concept, since they appreciate more their
friends’ advice, and predominantly use social networks to communicate and
search for information.

6. Conclusions
Bearing in mind the increasing importance of Digital Marketing and the influ-
ence of young generations on the market of electronic devices, this paper was
dedicated to the exploration of students’ preferences towards different strate-
gies that companies in this industry could create. The CBC analysis has shown
to be appropriate for this purpose. The results of this survey have practical
implications for the companies from this industry. As expected, our respondents
have assessed the Internet as a valuable source of information when making
a purchasing decision. They appreciate being able to find all the necessary
information online, especially on the company’s website. Once again has been
proven the students’ constant connectivity has important influence on their pur-
chasing behavior.
This is very vast and developing field that demands further research. The main
of our study was the homogeneity of the sample. There could have been more
meaningful information discovered if the respondents had differed more in their
demographic characteristics. It could have been made clearer distinction be-
tween the two observed generations, so that the significant differences could
be determined.
After proving useful for our research, similar approach could be applied on
other industries. Also, there are other elements of Digital Marketing that could
be subjected to research, such as e-mail marketing. Furthermore, more exten-
sive analysis of certain elements, for example, appearance on different social
media, website design, mobile application content etc. could give significant
results. This paper was focusing on the pre-purchase phase. Future research
could be directed towards post-purchase interaction, that includes tasks as re-
taining customers, assuring their loyalty, and developing customer relations.

519
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 CHAPTER 30

The Online Marketing Activities of Travel Agencies

in Slovakia

Branislav Dudić1, Martina Drahošová2, Zdenka Dudić3, Ján Smoleň4

ABSTRACT

Since we live in a modern and constantly changing society, it is important to be interest-

ed in information communication technologies, as presently move the world. And online
marketing and social media are part of these technologies. Our article is focusing on the
issue of present online marketing activities of travel agencies in Slovakia. In our article
we will mention the main and the most used online marketing activities. According to
Inbound marketing, what is online marketing methodology focused on the needs of cus-
tomers is said about these important steps in getting new customers: attract, convert,
close and delight. So, by following them we know the buyers journey of our customers.
In the next part of article, we will analyse the situation in this field of the biggest travel
agencies in Slovakia. How Slovak travel agencies are using online marketing activities
and how they act and interact with users and their potential customers on social media.
What kind of content they share on their web pages and what kind of content they share
on each type of social media they use for marketing purpose. In the last part of our
article, we will discuss about possible changes or improvements which we recommend
doing in future for travel agencies and in general for companies which want to be suc-
cessful in their marketing and online marketing activities.

Key words: marketing, online marketing, inbound marketing, travel agencies,

Slovakia

JEL classification: M31_Marketing, M37_Advertising

1 Assitant and researcher, Comenius University, Faculty of Management, Odbojárov 10, 82005 
Bratislava, Slovakia. Scientific affiliation: online marketing, information systems, project manage-
ment Phone: +421 91 5265 211 or +381 63 8555 482. E-mail: dudicbranko@yahoo.com
2 Researcher, Comenius University, Faculty of Management, Odbojárov 10, 82005 Bratislava,
Slovakia. Scientific affiliation: online marketing, information systems, project management Phone:
+421 2 50117505. E-mail: martina.drahosova@.fm.uniba.sk
3 Researcher and postdoctoral student, University of Novi Sad, Trg Dositeja Obradovića 6, 21000
Novi Sad, Serbia. Scientific affiliation: stategic management, innovation management, marketing
Phone: +381 63 8322646. E-mail: zdenkadudic79@gmail.com
4 Assitant and researcher, Comenius University, Faculty of Management, Odbojárov 10, 82005 
Bratislava, Slovakia. Scientific affiliation: online marketing, information systems, project manage-
ment Phone: +421 2 50117436. E-mail: jan.smolen@.fm.uniba.sk

527
1. Introduction
When any organization (profit or non-profit) operates in any business in current
internet age, it is important to be informed about effective marketing and online
marketing activities to promote its business, products and services. The second
thing is that we are in very competitive environment, so companies need to fight
for customers with their competitors in their business sector. This is the reason
to show to companies’ actual marketing and online marketing activities and to
recommend them most effective activities to make them original in their business.

2. Literature review
2.1. Marketing
Today, marketing management represents a responsibility for the fact that all
business activities performed in the market environment are oriented on busi-
ness objectives and aimed at achieving an agreement in the issue of satis-
fying the needs of target markets, which implies a responsiveness to market
needs, understood in an effective and profit-oriented manner. An integral part
of marketing activities is marketing communication as an instrument organisa-
tions use to achieve a relatively large amount of defined objectives. Market-
ing communication applied as a combination of currently used communication
mix instruments plays an important role in the processes of affecting purchase
decisions of the consuming public. One of the characteristic features of con-
temporary marketing communication is the fact that it notably encourages the
consumption of ultimate customers and participates in the creation of unsus-
tainable patterns of consumer behaviour on the one hand, while it (respectively
its instruments) can be decisive in the process of spreading the ideas of sus-
tainable lifestyle on the other.
Marketing communication (respectively communication mix or integrated mar-
keting communication) creates a substantial element in the marketing strategy
of an organisation. Marketing communication instruments are used in order to
achieve different objectives, for which responsibility is shared by both market-
ing managers and managers at other management levels, taking into account
the time and place viewpoints: to develop the awareness of a product; to ed-
ucate or provide information on products, a brand and/or an organisation; to
draw attention (remind) or reassure customers of a brand; to convince a po-
tential customer to try the given product; to reward those customers who have
purchased a product; to improve the image of a brand or an organisation; to
strengthen or maintain employee morale.
Notwithstanding the given wide range of objectives which can be achieved
applying individual marketing communication instruments, marketing commu-
nication is a significant subject of social criticism in marketing, even despite
legislative regulation of many of its elements in a number of cases. These (neg-
ative) aspects of marketing communication, respectively their perception and
evaluation by ultimate customers.
528
2.2. Online marketing
In traditional marketing, companies focus on finding customers and use tech-
niques that are interruptive. Customers are interrupt in their activity, such as
calls to customers or potential customers, by telephone, product offerings,
print ads, TV ads, or spam. Traditional marketing is marketer-centric because it
pushes the product or brand in front of the customer’s eyes, whether they are,
or they are not interested. From a practice perspective, these techniques have
become less effective.
Inbound marketing is the exact opposite of traditional marketing:
-- According to it, it is more appropriate to upload a video on the chosen
theme that your customers will be interested in, rather than disturbing
them by advertising about your product.
-- It is more effective to write a business blog, instead of buying ads in print.
You should present yourself with your expertise in the field, which would
inspire people to find your company.
Inbound marketing is customer focused. It educates and helps customers find
solutions and answers to their questions.
Inbound methodology presents four stages of inbound marketing and sales
process. These stages are Attract, Convert, Close, and Delight.

Source: HubSpot

The first stage of the methodology is to attract strangers, people who do not
yet know your company, to visit your website. Using tools such as blogging,
optimizing your website for search engines and social media will engage the
attention of aliens and create visitors from them. Visitors will become interested
in finding interesting content, so they will want to return to you in the future.

529
The next step is to turn some visitors into leads (potential customers). Lead is
the person who, in some way or in some form, has expressed interest in the
product or service of your company. This conversion is based on an offer of
interesting and valuable content to visitors for a certain amount. In this case,
the counter value is information about the visitors. As the company needs to
generate new contacts, it will offer for example eBook, as a counter value in
the form of the name and email of the site visitor. If he / she has an interest in
offered content, he / she will be willing to provide the requested consideration.
By providing personal information, the visitor becomes the lead.
The conversion tools are forms, for example, subscribing to a newsletter (e-mail
about company information). The second tool is Call-to-Action, a push-to-ac-
tion button, for example, subscribe to a newsletter or download a new eBook.
These will then take you to a landing page where you will be asked to fill in the
contact form to get the content.
In the third step, the company already has contact with leads who have ex-
pressed interest in their content. Now, the company has the opportunity to reach
out to them with tools such as email and CRM (lead customer relationship man-
agement) for leads and sell the product to the right lead at the right time.
Inbound is about delivering exceptional content to your users, whether they
are visitors, leaders or existing customers. Inbound marketing companies do
not even forget about their customers and try to continue to enjoy and engage
in conversations. This creates from them happy promoters of the products and
services, which they love.

2.3. Web 2.0 and Social Media

The term Web 2.0 describes trends and ways in which the web will probably
take. However, someone argue that Web 2.0 is just a bubble - marketing term
created how to amaze and gain customers with something that does not exist.
The second on the other hand see new quality and others say that Web 2.0 =
social media.
Social media have revolutionized the use of Internet as a tool to propagate prod-
ucts and promote their sale. Opens the possibility of less expensive and more
effective online marketing and also offer new approaches to direct contact with
potential customers, inspire in developing business and communication strategy.
Every day millions of users publish their articles, photos and videos with the
help of services such as YouTube, Flickr, Wordpress and share them with
others. The phenomenon of user-generated content got into the center stage
approximately in 2005 with the arrival of so-called waves of Web 2.0. Many
experts led by Tim O’Reilly pointed to the rising trend of involving the user di-
rectly to the creation of the site. Thus, formed web has become more targeted
and more useful. As best seen on sites that are now symbols of social me-
dia: Facebook (* 2004), YouTube (* 2005) and Twitter (* 2006). Probably with

530
the best definition came Andreas Kaplan and Michael Haenlein who identified
social media as “a group of Internet applications built on the ideological and
technological foundations of Web 2.0 that allow the creation and exchange of
user-generated content.”
Social media allow people to exchange ideas and opinions, discuss together
the content of pages and make contacts online. Social media is different from
traditional mainstream media in that their content can create everybody as well
contribute into it or comment on it. They may have a text format, may be an
audio, video or photographs and other visual forms that bring together commu-
nities, and assist people who want to associate together.
To make it easier to understand them, it is important to note that there are two
terms that sound similar, and many people are confused about them, they are:
social media and social networks. The term social media is superior to the
social networks and includes various media that people use for online com-
munication and collaboration and also to develop social interaction (sociabil-
ity). Social media include blogs, wikis, video or photo sharing sites and more
other things.
Creating social networks belongs under the social media and the term is used
when it is some way of people interaction, such as Facebook, LinkedIn, MyS-
pace and so on. We are talking about creating social networks when people
create personal profiles and interact with the aim of becoming part of a commu-
nity of friends and people who have “the same blood type,” that are interested
to communicate and exchange information.

3. Travel agencies in Slovakia

We can say that in Slovakia there are 90 bigger or smaller travel agencies,
which offer different services. Some of them are offering just summer holidays,
some just winter, some local and some of them foreign. There is big variety of
vacation they offer.
Act no. 281/2001 Coll. The Act on Tours, the Terms of Business of Travel Offic-
es and Travel Agencies and on Amendments to the Civil Code as amended (as
amended by Act No. 95/2002 Coll., 747/2004 Coll., 186/2006 Coll. 186/2006
Coll., 136/2010 Coll.) defines:
Travel office is an entrepreneur, 1a) who, based on a trade license, 2) organiz-
es, offers and sells tours and concludes a contract for the provision of a tour 3)
(hereinafter referred to as the “tour contract”).

531
3.1. Travel office
within the trade license under paragraph 1 below
a) organizes combinations of services, offers and sells to another travel
agency for the purpose of its further business,
b) offers and sells individual services or combinations thereof on the basis
of an individual order,
c) mediates the sale of individual services to another travel agency, travel
agency or other legal entities and natural persons (carriers, operators of
accommodation facilities, organizers of cultural, sporting and other social
events);
d) arranges sales of tours for another travel agency; The travel contract
must, in these cases, be entered into on behalf of the travel agency for
which the tour is arranged and the tour operator is responsible for the
performance of the tour contract,
e) sells things related to tourism, in particular tickets, maps, plans, bro-
chures, timetables, printed guides and commemorative articles,
f) organizes, offers and sells individual services or combinations thereof
which are not provided for longer than 24 hours and do not include ac-
commodation overnight,
g) provides tour guide services.

3.2. Travel Agency

(1) A travel agency is an entrepreneur, 1a) who, on the basis of a trade
license 2) performs services pursuant to § 3 par. 2nd
(2) In addition to the obligations under a special regulation4), the travel
agency is obliged to mark the establishment and promotional and other
materials designated for the ordering party by the words “travel agency”
if this name does not already contain its business name.
(3) The travel agency may not arrange the sale of a tour for a person who
is not a travel agency [§ 3 par. Article 2 d)].
(4) An operator, a member of a statutory body or a representative of a travel
agency may not be a natural person who has been revoked during the
last five years 2) for the operation of a travel office or travel agency due
to violation of the obligations imposed by law or due to bankruptcy.5)
Here are some statistics about tourism of Slovak citizens. Organized tourist
travels of Slovak citizens’ abroad (passive tourism) of the Slovak Republic in
2016:

532
 Average
No. Country Gateways Stay days
duration stay
1. Bulgaria5 120 514 923 324 7,7
2. Croatia 102 753 1 468 731 14,3
3. Italy 69 791 504 572 7,2
4. Greece 68 570 580 666 8,5
5. Turkey 40 356 356 285 8,8
6. Spain 22 728 168 158 7,4
7. Austria 22 724 49 459 2,2
8. Cyprus 13 643 118 604 8,7
9. Hungary 12 169 24 543 2,0
10. Egypt 11 988 106 353 8,9
Together 573 393 5 137 090 8.9
Source: Statistical office of the Slovak Republic, 2017

4. Methodology
For data analysis and article processing, we used the data from the statisti-
cal office of the Slovak Republic, data from social media analytics social bak-
ers and web pages and social media accounts of travel agencies in Slovakia.
We also used our own online marketing experience that focuses on customer
needs. Based on this data and information, we have created recommendations
for the effective use of online marketing activities.

5. Empirical data and analysis

In this part of article, we will discuss about practical online marketing activities
of Slovak travel agencies.

5.1. Online marketing activities

As we can see from picture below, according to social media analytics social
bakers, in area of travel agencies in Slovakia the largest audience have these
three travel agencies: Firo tour, Danny GOtravel and Slovakia travel. The fast-
est-growing travel pages in Slovakia are Firo tour fun page, Satur travel agency
fun page and Hechter travel agency fun page.
In this part of article, we will focus on online (inbound) marketing activities of
Firo tour travel agency, as one of the biggest travel agencies in Slovakia. This
travel agency has 76 364 fans on social network Facebook.

5 Data published by the Statistical Office of the Slovak Republic. According to the records of the
airports, Bulgaria visited 46,608 visitors.

533
Source: Social Bakers

Besides social network Facebook, they act on other as on Instagram, YouTube,

Google+ and Twitter. However, the main concentration is on Facebook, as it is
the most used social media in Slovakia. On Facebook, they share all kinds of
content, from offers of vacation, through pictures, official videos and life videos
from destinations, to blog posts about destinations. In advance, they create
contests for their customers or funs.
On other social media channels, they act mainly on daily basis but the conver-
sation with users is not natural. For example, on Instagram, they share pictures
and short videos, of course about that is this social media. Nevertheless, main
part of pictures and videos are not authentic from destinations (see picture
below). The same situation is with videos shared on social media YouTube.
Videos, which they share here, are official videos of hotels, which are often not
showing reality.

534
 Source: firotour_slovakia Instagram, 2018

Regarding to account on social network Google+, actually they do not use it.
Last post on Google + was published in March 2016. Even before, they did not
use this social network very often. The reason is that this social network is not
very used in Slovakia and all over the world. The company has there just 58
followers.
Microblog Twitter is used for sharing posts from Facebook. In addition, compa-
ny has here 135 followers, what is not enough to interact with users.
To conclude online marketing practices of this travel agency and others in Slo-
vakia, we can say that these companies are using many of effective activities
for attract their prospects and to engage their customers but every time there is
a space for improvements. In the next part of our article, we will offer for them
recommendations for them, the important activities that they should do to be
successful in their marketing and online marketing.

535
6. Results and discussion
In spite of an increasing number of market driving forces and the fact that market
environment has become hypercompetitive, marketing is overlooked and mar-
ginalized in many cases. One of the causes can be the fact that “side effects”
of marketing have defeated the defined key effects. Can this situation be im-
proved? Several variables in the customer – organization – society relationship
need to be rethought in order to compensate. Marketing used to be declared
a representative of customers in organizations, however, in fact, it represent-
ed (also using unfair practices in many cases) an organization of customers
by means of endless innovations, aggressive marketing communication, etc.
Marketing does not work in its traditional concepts any more, which is why it is
necessary to identify with a new view of it. According to Kotler (Kotler, 2007),
the contributions of marketing include the facts that it has improved the quality
of life, played an important role upon creating markets and products, increasing
comfort and general enriching of life. The boundary between a healthy, rational,
responsible and sustainable approach to marketing and a moment when such
an approach becomes harmful is questionable.
Where many current marketing strategies are channel-specific and weak, cus-
tomer experience strategy from the marketing communication point of view is
holistic and integrated. Where the majority of current advertising is loud and
fleeting, rich customer experiences and interactions are personal and immer-
sive. Where brand communication is designed today to speak about the bene-
fits of a product or service, customer experience design improves the offering
itself. Customer experience management in marketing communication is about
considering the customers’ perspective in everything companies do and every
decision they make in order to ensure a mutually beneficial relationship and
provide customers with valuable experiences.
According to inbound marketing, we recommend to companies these activities:
-- at first start with optimization of your web page, incorporate to your con-
tent on web page right key words, do not forget to optimize for mobile
devices,
-- create your buyer personas (your ideal customers) to concentrate on
right content for right people,
-- create educative content for your prospects and customers, there are
many kinds of content you can create, e.g. blog posts, infographics from
your business or sector, eBooks, guides how to do something or how to
use your products, educative videos, videos from your stone shops, life
videos from destinations, webinars, podcasts etc.
-- post all of your created content on your web page and do not forget to
apply appropriate key words for your content,
-- post content shared on your web page on your accounts on social media,

536
 -- do not offer all content for free, your exchange value from interested
prospects can be information about them, e. g. their name and their
e-mail and this information you can get thanks to call-to-action buttons
and landing pages,
-- when you already have information about your prospects then you know
that they are interested about your products or services, then you can
contact them by right and interesting e-mail, e. g. to inform them about
other content which can interest them and on the end you can offer them
products or services from your portfolio which can be appropriate for them,
-- all these activities are very important for improving your position in re-
sults of search engines, so don’t forget on any of them.
Other recommendations for social media and content creation:
-- Optimize for five seconds because people do not study profiles. They
spend a few seconds looking and make a snap decision. Your profile
should be likeable, trustworthy, and competent. Do not forget enter to
your profile these important information: avatar (profile picture or logo of
your company), cover or header picture which tells your story, biographi-
cal text and links (to you web page, blog or other social media accounts).
-- Have same avatar or logo of your company on all social media accounts,
to help people to recognize you and not confuse them.
-- Create your own mantra with message why your company exists.
-- Plan your marketing and online marketing activities and sharing of your
created content.
-- If you want to create your own content and share it with your prospects
and customers you should love to write be creative and to publish, be-
cause you are publisher.
It is important to be yourself so to know you and your company, to get your
brand story voice. Then it is important to know your customers, to know what
they need and what their objectives are.
-- In creation of your content focus on your objective, because your content
should be created with intent, for someone, to get something.
-- Speak in customers’ language to clearly communicate your values and
mission. Do not use special terminology of your industry; communicate
in simple language with simple terms for everyone.
-- Good content does not try to sell, so do not try to sell your products in
your content. Content should educate and add value to your customers.
Your content should solve problems, share resources and help your cus-
tomers do their jobs or other things better and more effective. On the oth-
er hand, it helps your company to position you as a reliable and valuable
source of information so you are getting more competitive.

537
 -- Do not forget that you should tell true stories to your customers by of-
fering them case studies or client narratives to show them how your real
customers use your products or services and how it adds value to them.
-- Here is not important to do everything and be everywhere. You do not
need to create huge spectrum of content, try some of them and decide
which work for you and concentrate on these type of content. The same
is with publishing of your content, chose some social media that are
appropriate for your business and share your content there where you
know that your customers are.

7. Conclusions
In this high competitive environment, it is not easy for companies to attract
prospects to their businesses. Because of that, it is important for them to follow
trends in online marketing to know how offer and present their business. In our
article, we presented actual situation of marketing and online marketing prac-
tices and offered recommendations for travel agencies for effective marketing
and online marketing activities.

538
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 CHAPTER 31

Preferences for Carsharing Service Attributes:

A Survey of University Students in Belgrade

Nataša Bojković 1,Veljko Jeremić2, Marijana Petrović3, Slaven Tica4

ABSTRACT

Carsharing is a mobility service and a specific business model launched in many cities
worldwide. The research investigates the prospects to bring carsharing to the market
where it is not yet developed. In doing so, an extensive survey was conducted among
university students in the city of Belgrade. This specific target group is recognized as
promising, because students are more receptive to new services, have intensive mobility
needs and operators are partnering with universities for mutual benefits. Preferences for
particular service attributes were explored using a choice-based conjoint analysis. Fur-
ther market segmentation was obtained using the Partitioning Around Medoids (PAM)
method. The study finds two principal clusters - users whose participation in carsharing
is heavily dependent upon purchasing costs and those who express an equal interest in
price and other service attributes. To match the requirements of both target segments,
carsharing operators should consider more than one service package.

Key words: carsharing service, university students, stated preferences,

choice-based conjoint, market segmentation

JEL classification: C44, R40

1. Introduction
Carsharing (CS) is a mobility option and a specific business process in which
operators provide customers with an access to passenger cars. This on-demand
and membership-based mobility service is typically foreseen for short-term rent-
al but allows a long one as well. As for daily mobility, carsharing offers flexibility
and autonomy for the driver, without having financial burden of car ownership.

1 Dr Nataša Bojković, Associate professor, corresponding author, University of Belgrade, Fac-

ulty of Transport and Traffic Engineering, Vojvode Stepe 305, 11000 Belgrade, Serbia, Phone:
+38163366114, E-mail address: nbojkovic@yahoo.com
2 Dr Veljko Jeremić, Associate professor, University of Belgrade, Faculty of Organizational Sciences,
Jove Ilića 154, 11000 Belgrade, Serbia, Phone:+30913950800, E-mail address: velja64@gmail.com
3 Dr Marijana Petrović , Associate professor, University of Belgrade, Faculty of Transport and
Traffic Engineering, Vojvode Stepe 305, 11000 Belgrade, Serbia, Phone: +381113091281, E-mail
address: marijanatpetrovic@gmail.com
4 Dr Slaven Tica, Associate professor, University of Belgrade, Faculty of Transport and Traffic
Engineering, Vojvode Stepe 305, 11000 Belgrade, Serbia, Phone:+381113091200, E-mail address:
slaven.tica@gmail.com

541
From the perspective of individual users, sharing vehicle enhances mobility op-
tions for carless population and potentially saves (or reduces) personal trans-
portation costs (Boyaci et al., 2015). Being able to accommodate occasional
car usage, carsharing fulfils mobility needs of those who cannot afford or do not
wish to buy a car.
From the sustainable mobility perspective, sharing schemes tend to optimise
car usage, both by increasing time utilization (Csonka and Csiszár, 2015) and
by the ‘pay-as-you-drive’ principle (Dotter, 2015). It is one of the solutions to
cope with common urban problems like congestion, parking and inefficient use
of limited public space. Previous research reported that people (households)
sell cars or forgo their purchase after joining the carsharing programme and
shift towards public transportation and active modes (e.g. Martin and Sha-
heen, 2011; Giuliano and Hanson, 2017; Zavaglia, 2016).The long-run effects
of carsharing are widely investigated. Reduction in car ownership and vehicle
kilometers are the most notable benefits. The exact number of private vehi-
cles that can be or are replaced by a carsharing vehicle as well as the effects
on total vehicle kilometres traveled (VKT) are difficult to determine precisely.
The figures vary according to local specificities, calculation methodologies but
also according to carsharing business models (for more discussion see Fer-
rero et al., 2015 and De Barros, 2015). By reducing the total VKT, carsharing
delivers a positive environmental effect in terms of energy savings and CO2
emission reductions. This is associated with the composition of the fleet as
well - the carsharing vehicles are generally newer, smaller and more energy
efficient. Moreover, it is expected that electric vehicles will play a primary role in
service provision.
Although the idea of carsharing dates back to 1940s, this transportation option
has experienced its growth much later. A considerable impetus for wider imple-
mentation gave the development of information and communication technolo-
gies (ICT). CS operators use ICT to manage the fleet in terms of distribution,
utilization and maintaince, while users benefit from improved reservation sys-
tem. Another stimulus was the integration and joint organization of urban trans-
portation system, where CS is perceived as complementary to public transport.
This has enabled institutional support and partnership between carsharing
operators and local governments (Terrien et al., 2016) and public institutions
like universities. Not of less importance for greater success of CS is a societal
transition where car would be no longer a symbol of status, and access to the
assets would be valued more than ownership. Along with the creation of favora-
ble environment, CS itself evolved into more flexible business models. In the
traditional, round-trip model, vehicles should be returned to the same location
from which they were picked-up. In one-way model, users are allowed to make
one-way trips and return a vehicle to a different location from where it was ac-
cessed. There are two types of one-way CS: station-based and free-floating.
Station-based concept requires customers to leave a vehicle at fixed stations.
Free-floating is the most flexible service since a vehicle can be accessed and

542
left at any public parking lot within a designated zone (the so-called operating
or business area). The common features of all models are the constant availa-
bility of service (24/7) and rates which include fuel, parking, maintenance and
insurance costs (Shaheen et al., 2015).
As regard industry growth, the projections from 90’s appear to have been too
optimistic, but the global trend is promising (Shaheen and Cohen, 2016). This
is particularly true over the past few years, with the launch of new forms of ser-
vice. More flexible one-way and especially free-floating concept is a chance for
CS to expand from niche market into the mainstream.
Measured by service per capita, Europe is currently the largest market, followed
by the North American one. In terms of the total number of users, Asia-Pacif-
ic region stands out, due to large customer base. Along with Japan, with the
longest CS tradition, Australia, China, New Zealand, Singapore, South Korea,
and Malaysia are currently among prominent markets of this region (Bert et al.,
2016). Generally, less developed countries are newcomers in CS practice. Due
to limited history, there is a lack of knowledge about the business viability. As
pointed out in WRI (World Resource Institute) report (Lane et al., 2016), many
questions have yet to be investigated, among which are barriers and opportu-
nities for implementation, potential market, service design and finally societal
and environmental impacts.
At this moment the worldwide development is rather uneven/highly concen-
trated. Even in Europe, which is the cradle of CS, there are countries hav-
ing a well-established service (especially Switzerland and Germany) but also
those where it’s not even known how carsharing works. The main motivation of
this paper is to shed light on potentials of the industry in Belgrade, specifically
among university students, which is a population of intense daily movements.
The aim is to investigate their preferences for particular service attributes,
which is the basis for appropriate service design to be developed.
The rest of the paper proceeds as follows. The next section presents previ-
ous work on the topic. It is organized in two parts. The first refers to ongoing
practice with students’ participation in carsharing programs, while the second
highlights commonly used methodologies for preference investigation. Section
3 brings relevant information related to Belgrade as the study area, and the
description of survey. Research results are presented and discussed in Section
4, followed by concluding remarks.

2. Related work
2.1. University students as a carsharing market segment
University students are becoming increasingly recognizable as one of the tar-
get audience for CS operators. Important characteristic in favour of this custom-
er group is that they are more open to new services and more familiar with ICT
than the older generations. Besides, it is easier to break through this market

543
since students just start making their travel decisions and, as discussed in Da-
vison et al. (2015), their commuting habits have not yet been formed. At the
same time, owning a car may be uneconomical for this customer group. This is
because their need for car is generally sporadic, especially for long journeys,
as well as because they still need to strengthen financially.
High rates and the insurance restrictions for young population below 21 years of
age are major barriers to penetrate into this market. Nevertheless, some of the
leading CS companies (like Zipcar, The Enterprise CarShare and Car2go) are
already partnering with universities around the world. They have tailored their
service to grow customer base in different manners - various discounts are put
in place (reduced fees and/or membership), age requirement is lowered to 18
and vehicles are located close to campuses or at dedicated lots within the cam-
puses. Universities benefit from the agreement with CS operators in different
ways. First, CS provides greater accessibility for students, teaching and other
staff. According to an extensive survey among students at universities across
the U.S and Canada5, CS is especially important for improving the quality of
life for students staying in more isolated campuses. Second, maybe the most
important benefit from partnership with CS operators is reducing parking de-
mand. Third, with the cs adoption, universities demonstrate their environmental
awareness and commitment (Zheng et al., 2009). A considerable number of
academic papers have been devoted to university student travel patterns (see
for example Zhou 2012a, 2014, dell’Olio et al. 2014, Danaf et al. 2014, Davison
et al. 2015, Rotaris and Danielis 2015), however carsharing university market
is less investigated. Several field research that have brought the answers on
some aspects of interest are cited below.
Stasko et al. (2013) conducted a survey among student members of CS oper-
ator in Ithaca to reveal the impact of carsharing on vehicle ownership, parking
demand and travel behaviour. Using collected information on service-related
user preferences, Zheng et al. (2009) developed models to predict the will-
ingness to join carsharing program at the University of Wisconsin–Madison.
Pricing and vehicle access distance were selected as membership package
features that mostly affect the potential CS market share. It was also point-
ed that student status (undergraduate, graduate, foreign-exchange or visiting
scholar) may have stronger influence on CS acceptance than socioeconomic
status, which is a specificity of university community. Le Vine et al. (2014) found
an increase tendency to use one-way service type among full-time students. A
study by Zhou and Kockelman (2011) reports that without prior experience with
CS and without special programs for universities students will be less likely to
join. These findings are based on a survey which was carried out in Austin (Tex-
as) at the time of the launch of the first CS service. The authors assume that the
shuttle and free of charge bus service for University of Texas students are more
attractive than costly carsharing. Breitner and Klein (2014) have searched for

5 https://www.universityofcalifornia.edu/news/car-sharing-campuses-improves-quality-life-takes-
cars-road

544
an optimal pricing model that would provide maximum revenue for CS operator.
Students from Leibniz University Hannover were asked to name the amount
that they would be willing to pay for different trip scenarios. This research has
demonstrated that there are specific trips, where car sharing is far more con-
venient than public transportation. Hence, students are ready to pay even if
they have free travel tickets for wider urban area. Danielis et al. (2015) inves-
tigated the potential demand for CS at the University of Trieste. It was found
that more than half of the students had very little knowledge of what CS was.
On the other hand, higher level of knowledge as well as higher level of environ-
mental consciousness is reported to be of importance for probability of use. The
sensitivity to service design was also examined. The CS price and less time to
vehicle access, as well as more time for car parking, would significantly affect
the probability to opt for CS.
A specific study was done by Puandra et al. (2017) where decision for car-
sharing was investigated from the perspective of “psychological ownership”
i.e. individual’s affection towards an object. The respondents (undergraduate
students) were asked to state their intention to select carsharing, described
by three attributes - price, parking convenience and car type. While parking
convenience was found not to be affected by the level of the psychological
ownership, other two parameters were with effects. The price of a service was
important for respondents with low psychological ownership, while it was less
decisive for those with high psychological ownership. Also, only respondents
who scored low on psychological ownership were willing to pay more for an
electric shared car service.

2.2. Methodological background

To investigate the demand characteristics of carsharing market that is not yet
established, a stated preference approach is exploited. This is considered a
suitable tool to illuminate the behaviour of people who had no or had little prior
experience with car sharing (Efthymiou et al., 2013; Jorge and Coreira 2013).
In this respect SP have been used both to explore preferences of car sharing
early adopters (e.g. Zheng, 2009) as well to analyse the willingness to join car
sharing schemes (e.g. Efthymiou et al., 2013).
Stated preferences discrete choice modelling (SPDCM) approach helps the re-
searchers to uncover how the users value different car sharing service attributes
or different transport alternatives by asking them to rank or rate set of alterna-
tives (so called contingent ranking) or to choose the most preferred option from
a choice set (referred as ‘discrete choice experiments’ - DCEs or ‘choice-based
conjoint analysis’-CBC). In discrete choice experiments sets of alternative pro-
files are provided to the user (in a form of choice questions) and each profile is
described by different mix of the attribute levels. The important feature of choice
experiments is that they address hypothetical service attributes with reduced
cognitive load and integration of a non-purchase option - respondents are not
compulsory to select unacceptable alternatives (Hildebrandt et al., 2015).

545
It is also worth noting that some studies exploit SP surveys with hybrid choice
model i.e. include latent variables to address mid-term (Kim et al., 2017a; Efthy-
miou and Antoniou, 2016) and short-term (Kim et al., 2017b) car-sharing deci-
sions, or combine them with agent based simulations (e.g.; Ciari and Axhaus-
en, 2012; Martínez et al., 2017).
A stream of research exploited SPDCM for investigating modal selection –
choosing carharing over other modes like bus, para-transit or private car (Fuku-
da et al., 2005); carpooling, private car, public transport (Catalano, 2008); car
as driver, car as passenger, car-pool and bus (De Luca and Di Pace, 2014,
2015).
Among first attempts to elicit preferences for car sharing on the basis of SP and
CBC was done by Johnson et al. (1998) who analysed a proposed car-shar-
ing concept at Daimler-Benz. They were able to track the differences in users’
preferences depending on different characteristics like car-ownership, level of
urbanization, etc. Abraham (2000) investigated car sharing non users with SP
technique and INVIEW conjoint software (Hunt et al., 1995) with the aim to eval-
uate the impact of hypothetical service attributes on the overall attractiveness
of car sharing in Calgary, Canada. The hypothetical car sharing organizations
were described with 11 different attributes which were further randomly com-
puter generated. The choice data were analysed with logit model. The resulting
utility function revealed that respondents are more interested in lower prices
than membership deposit, while the preference for shorter walking distance
was initially found to be quite low. Yoon et al. (2017) modelled preferences for
one-way and round-trip CS in Bejing on the basis of hypothetical choice sets
around actual trips. They included several attributes (weather, car type, price,
etc.) and found that the difference between cost for carshare and original mode
is the most influential on both CS variants, while car ownership was with di-
verse impact (positive in one-way and negative for round trips).
Several SPDCM studies focused on a particular carsharing attribute or aspect
like information systems (Hildebrandt et al., 2015) or electric vehicles (Kramer
et al., 2015; Zoepf and Keith, 2016; Carteni et al., 2016; Yoon et al., 2017).
Hildebrandt et al. (2015) relied on choice-based conjoint analysis to explore
and evaluate the role of information systems for car sharing attractiveness.
They found that convince of car sharing is dependent on IS uptake, having that
users prefer mobility services independent of the engaged operator and of their
location. Reservation was found to be the most valuable attribute. Kramer et
al. (2015) utilized conjoint to investigate users’ preferences about integrating
electric car sharing system into public transport system in Berlin. Zoepf and
Keith (2016) exploited conjoint experiment to explore the potential of electric
vehicles (EVs) within ZipCar. For attributes were considered: distance to the
location of vehicles, the availability of vehicles at the desired time, and rental
price of vehicle rental. Results showed that carsharing users prefer driving a
hybrid vehicle over a plug-in electric vehicle. Also, the utility of hybrid and elec-
tric vehicle decreases with increasing reservation distance. Utilizing SPDCM,

546
Cartenì et al. (2016) investigated the EVs and carsharing, in terms of ‘pure
preferences’ for EVs (i.e. excluding other factors) in the city centre of Salerno
(Italy). They found that user decision is very much influenced by travel cost,
whereas this was not the case with variations in total travel time.

3. Conception of analysis and empirical data

3.1. Study area
The city of Belgrade with a population of around 1.700.000 inhabitants is the
fourth largest in Southeast Europe. Belgrade is the leading city of higher edu-
cation in Serbia. Students account for about 7% of the total number of Belgrade
population 6.
There are 11 student residences scattered throughout the city’s urban neigh-
bourhoods, providing accommodation for more than 11000 students. The larg-
est dormitory (with more than 6000 students living in it) „Studentski grad”, is
situated in Belgrade’s municipality of Novi Beograd, and is about 6 km away
from the city centre. Faculties are located at different Belgrade’s municipalities,
but the majority are in or close to the downtown district.
Public transport (PT) system as the most affordable is the dominant mode of
student travel in Belgrade. According to research on the professional status
of PT users, students account for 16,42% which is a considerable share in
total number of trips (2,5 million per day). The students’ monthly travel ticket
is subsidized and costs about 12 Euros. With a monthly travel ticket, students
can realize an unlimited number of trips on the entire network of lines in the
city area. The system is well developed with 150 lines running daily from 4.00
am until 12.00 pm, and 25 night lines. The network density is high-5,256 km/
km2 and nearly 75 % of citizens live within a five-minute walking distance to the
nearest transit stop (stop catchment area), or 400 metres in diameter (Tica et
al., 2015). Some of the recent improvements are electronic fair collection and
real time management system.
Bearing in mind that Belgrade has not yet introduced the higher capacity trans-
port options, like metro or light rail system, it is not surprising that current PT
is operating under increased pressure. Due to budget constraints, the fleet is
only partially renewed and is still outdated, especially the buses which are the
backbone of the system. Vehicles are often overcrowded, let alone that some
operate without air-condition system. Interference with a car traffic and limited
number of night lines also affect the level of service. According to the latest
in-depth research about users’ satisfaction the average rate for level of service
has dropped. The average PT satisfaction grade was 2,81 (on 1-5 scale) in
2017, while it was 3,4 in 2007. Reaction to the weaknesses of PT was most
extremely expressed by students who rated the system lower than the other
user groups.

6 Statistical Office of the Republic of Serbia

547
As reported by the latest survey, punctuality and regularity, frequency of service
and travel time are the most important attributes for students. This suggests
that for particular trips, especially those where public transport would have tak-
en too long, a more flexible service might be a desired option. Apart from pri-
vate car, taxi is the only flexible mobility option that is currently put in place. It
is however not only expensive to be regularly used, but also with limited capac-
ities especially during the disrupted functioning of the urban transport system
caused by traffic congestion.

3.2. Survey
Before developing a conjoint-based survey, a preliminary test was performed
on 170 respondents. Having that the typical conjoint study involve limited num-
ber of attributes (up to six, Orme, 2002), the aim was to reveal the most impor-
tant aspects of service delivery. They were selected on the basis of how the
leading companies (DriveNow, Car2go, Autolib, Zipcar) operate on the market.
The focus was on one-way service, as more flexible and likely more receptive
renting concept.
At the beginning of the questionnaire, students were informed of the basic
principles of one-way carsharing functioning. The questionnaire contained 15
items. They were related to the vehicle fleet (size, age, brand, cleaning), res-
ervation and payment system, accessibility of vehicles, parking spots and user
benefits issues (see Table 1). Respondents were asked to specify four attrib-
utes that they perceive as the most important. At this point of the research, the
price of the service was not explicitly included, because its significance was
presumed to be unquestionable.
Based on this preliminary test, we have generated the most important stimuli
for cs on the basis of frequency of attribute selection (Table 1).

548
 Percentage of
Attribute Rank
respondents
Distance to getting a vehicle 59,57 1
Vehicle cleanness 58,16 2
The number of spots to park the vehicle during or
55,32 3
after use
Pricing scheme (by-the-minute rate or hourly rate only) 53,52 4
Information about the current availability of parking
51,77 5
spaces (e.g. via mobile phone application)
Annual membership fee 48,59 6
Possibility to book a vehicle in advance (e.g. for more
46,48 7
hours or for more days)
Possibility of cancellation of reservation of the vehicle
43,97 8
free of charge
Payment options (mobile phone, payment card, etc.) 39,72 9
The size of the operating zone (where vehicle can be
37,59 10
accessed and left)
Benefits for regular users (reward points, booking
34,04 11
priority and the like ...)
Age of the fleet 30,28 12
Vehicle size 17,61 13
Obligation to define the renting period in advance 12,77 14
Vehicle brand 12,68 15

Table 1. Ranking of attributes within preliminary test

These are the following attributes: distance to vehicle, pricing scheme, parking
spots and vehicle cleanness. Together with the renting rate, they form the input
for a choice-based survey/conjoint experiment. Each attribute is made up of
levels, specified to correspond to the existing CS services (Table 2). For exam-
ple, walking distance for getting to a vehicle is set to be up to 800m which is,
according to the empirical evidence, considered acceptable (Schmöller et al.,
2015; Csonka and Csiszár, 2015).

549
 Attribute Levels
A. Pricing scheme A1. By-the-minute rate
A2. Hourly rate only

B. Cleanness B1. Vehicles are cleaned and washed daily

B2. vehicles are cleaned and washed twice a week

C. Distance to getting a C1. Up to 400m

vehicle C2. Up to 800m

D. Renting rate D1. 1200 RSD

D2. 1400 RSD
D3. 1600 RSD

E. Parking spots E1. Free of charge in any approved legal spot

E2. Free of charge in any approved legal spot plus in
the reserved/dedicated locations of the company.

Table 2. Attributes and levels

The research was carried out using the choice-based conjoint online platform
Conjoint.ly (Samoylov & Kayande, 2017). A sample comprised students from
different faculties of Belgrade University (Faculty of Organisational Sciences,
Faculty of Economics and Faculty of Transport and Traffic Engineering)
After initial page where more details about the carshare service was provided,
a set of questions where respondents were asked to choose one of the three
CS options (encompassing previously stated attributes) have been presented.
Finally, several socio-demographic questions have been included to shed addi-
tional light on research questions. The peak period of data collection occurred
in the week October 15th – Oct 22nd, where students of undergraduate studies
were asked to fill up the survey with their participation being awarded with ad-
ditional course credits.
We applied the choice-based conjoint analysis in order to explore user prefer-
ences. Obtained results were furthered scrutinized using the descriptive and
multivariate statistical methods. In particular, users have been segmented us-
ing the Partitioning Around Medoids (PAM) method. Prior the PAM method,
outliers were removed from the analysis using the multivariate outlier detection
based on the Mahalanobis distance.

4. Research results
In total, 954 fully answered responses were collected. Out of that number, 36
respondents were excluded from the analysis since CBC determined incon-
sistency in their responses. Since the pre-processing of data should be done

550
before conducting any analysis, we analysed our dataset (attribute importance
scores on the individual level) for the outliers.
Outliers could be defined as observations, which deviate significantly from the
rest of the data so that it seems they are created by another process (Hawkins,
1980). Outlier detection proves to be of high importance for the results of the
CBC analysis (Ku et al., 2017). Therefore, it is recommended to identify the out-
liers before conducting any data mining analysis (Rehm et al., 2007). One of the
commonly cited approaches to multivariate outlier detection is the Mahalanobis
distance (Ben-Gal, 2005; Tabachnick and Fidell, 2007; Jayakumar and Thom-
as, 2013). Mahalanobis distance assumes that the data is multivariate normally
distributed and it follows a Chi-Square distribution with d degrees of freedom,
where d is the number of the observed variables. After the Mahalanobis dis-
tance was computed, the probability that the Mahalanobis distance is greater
than the Chi-Square distribution with d degrees of freedom was obtained. A
maximum Mahalanobis distance larger than the critical Chi-square value for df
= d at a critical alpha value of .001 indicates the presence of one multivariate
outlier (Tabachnick & Fidell, 2007). After conduction this analysis, 11 additional
responses were excluded leading to the final dataset of 907 respondents which
were further scrutinized.
The sample consisted of 41,9% of males, the majority of the respondents (52%)
graduated from the high-school in the capital (Belgrade). Nearly half of respond-
ents (49,6%) live with their parents and 49,7% switch couple of PT lines on their
way to faculty. Our respondents don’t tend to use taxi services (83,4% use
them rarely or never), nor the specialized bus (e-lines) services (96,5% rarely
or never use the e-lines). Only 31,1% are familiar with the carshare services,
solely 1% actually used carshare, while 7,4% have a friend/acquaintance who
has used a carshare service before.
With the principle idea of the paper to determine user preferences towards the
carsharing services, we further analysed the attribute importance scores by
clustering the sample of 907 respondents in several market segments. Herein
we suggest the implementation of non-hierarchical cluster analysis, Partitioning
Around Medoids (PAM) method. PAM is an implementation of the K-medoids
algorithm. The algorithm partitions the observations in clusters and minimizes
the distance between the observations assigned to a cluster and its centre
(Kaufman and Rousseeuw, 1990). PAM has several favourable properties: per-
forms clustering with respect to any specified distance metric, identifying clus-
ters by the medoids. Thus, each element is considered as a potential medoid
while holding the other K-1 medoids fixed (Van der Laan et al., 2003). Namely,
one of the advantages of the PAM method is the silhouette plot that shows how
well cluster members are positioned within their respective clusters. Besides,
the calculation of the predefined number of clusters, it is possible to use the
silhouette average widths for assessing the best number of clusters. In our
research, both silhouette score and Calinski-Harabasz index (Caliński and Har-
abasz, 1974) proposed three clusters as depicted in Figure 1.

551
First cluster (StudentsOnTheBudget), with 25,69% of respondents, is depicted
with the highest score for the attribute Renting rate (60,627) meaning that this
is the crucial aspect of carshare service that they seek. On the other hand, third
cluster (CleannessComesFirst), with 26,35% of respondents, is characterized
with the highest score for the attribute Cleanness (41,023). Second cluster,
not only because of its size (47,96% of sample) but also because it exhibited
variety of individual’ preferences, lead to further clustering approach. Both sil-
houette score and Calinski-Harabasz index determined three clusters with the
Cluster2.1 and Cluster2.2 being more cost oriented (attributes Pricing scheme
and Renting rate), while Cluster2.3 encompasses both cost and comfort orient-
ed attributes.

Figure 1. Segmentation of the respondents based on their carsharing preferences

As we can see from the Table 3, cost oriented attributes dominate our sample
with only Cluster3 being the representative of students which prefer comfort
over cost in the carsharing service.

Group of
Cluster1 Cluster2.1 Cluster2.2 Cluster2.3 Cluster3
attributes
Cost oriented
74,382 77,035 80,547 58,800 41,425
(A+D)
Comfort oriented
25,618 22,965 19,453 41,200 58,575
(B+C+E)
Table 3. Cost vs. Comfort clusters

552
5. Conclusions
With all its potential benefits and flexibility, carsharing still appears to be a lux-
ury service in less developed countries. Nevertheless, there are certain mar-
kets where it is reasonable to believe that carsharing might have a prospective
future. One of them is the student population, mostly because they are more
open to new, ICT-based services and increasingly adoptive of sharing econo-
my. As regard university students in Belgrade, their intensive need for mobility
and the decline in satisfaction with public transport indicate the potential suc-
cess of carsharing.
The findings from this study revealed that we can basically distinguish two user
groups among Belgrade students. The first, and not surprisingly the dominant
group, are those whose participation in carsharing program is heavily depend-
ent upon purchasing costs. However, this research has outlined the second
group of about a quarter of the respondents, who expressed an approximately
equal interest in the price and comfort oriented attributes. This finding is en-
couraging meaning that the introduction of CS program for students in Belgrade
should not necessarily be on hold. Apparently, it is unlikely that a single type of
service will match the requirements of both target segments. Hence, the car-
sharing providers should consider more than one service package.
It is worth to note that there is a noticeable lack of research about travel behav-
iour in Belgrade. Beside that this study illuminated students’ preference for car-
sharing, it can also give impetus for similar research among other user groups.
Insufficient knowledge and lack of prior experience with carsharing are the
main limitation of the research. The results would be more reliable if prior to
the survey the students were given the opportunity to try carsharing service
(using for example gift cards for students like in the study of Zhou, 2012b).
Our future research will include the in-depth analysis of user demographics, in
order to improve understanding of motivation factors and to design appropriate
service packages.

553
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 CHAPTER 32

The Role of Personal Relationship and Information

Technology in Business Markets

Erzsebet Hetesi1, Klára Kazár2, Balazs Revesz3

ABSTRACT

In this paper we investigate the role of personal relationships in business markets in

the information technology era. In particular we were interested in how the spreading of
usage of information technology affects the importance of personal relationships, trust,
commitment or loyalty in the business to business relationships. The results from our
combined qualitative and quantitative research program indicate that while information
technology transforms the methods of interaction in business relationships, personal re-
lationships still keep their importance. The social embeddedness of economy still seems
to exist in our post-modern, technology driven world. The interpersonal relationships
and networks of these relationships still seem to play an important role in business life.
Based on our results we believe that both (face-to-face and information technology me-
diated) types of encounters can be effective.

Key words: relationship marketing, information technology, customer

relationship, personal relationship, relationship management

JEL classification: M30

1. What makes relationships successful?

In the literature one can find a lot of research dealing with the successfulness
of business relationships (Dyer 1997), where success is mainly characterized
by implicit meanings such as the efficiency, the prior expectations and realized
goals, or the sustainability. However the reason why a business relationship or
the participation in a network is considered to be successful is largely diverse.
The success of the relationship cannot be measured only in numbers. There
are a lot of other factors that can influence its judgement. There can be a sig-
nificant difference between the business success and the relationship success.
Whilst the business success can be measured by revenues, profit, or market
share (Ellram 1995, Chikán & Czakó 2009), the relationship success can be
evaluated from other aspects. Often factors such as the management of the
relationship, conflict management, fairness, trust, commitment, loyalty between

1 PhD, University of Szeged, Hungary, hetesi@eco.u-szeged.hu

2 PhD, University of Szeged, Hungary, kazarklara@gmail.com
3 PhD, University of Szeged, Hungary, reveszb@eco.u-szeged.hu

559
business partners can make the relationship successful. All these dimensions
of relationships can hardly work without personal contacts, personal encoun-
ters and sympathy, human and psychological factors.
One of the leading concepts of the B2B relationship marketing is the com-
mitment-trust theory by Morgan and Hunt (1994). The authors consider these
two factors as the most important ones in the relationship marketing. Another
aspect of the success of the business relationship is the theory that examines
the effect of the customer satisfaction and the relationship quality in the con-
text of the customer behaviour (that is loyalty) (Hennig-Thuaru & Klee 1997).
This model suggests that the perceived relative quality, the satisfaction, the
perception of the quality of the relationship, the commitment and trust alone or
altogether can not describe exactly the nature of the loyal customer behaviour,
since other factors such as inner psychological or contextual characteristics
can also affect the decision of the customer.
As shown above, studies refer the following characteristics of a stable, long
term relationship: perceived quality, satisfaction, commitment, trust, coopera-
tion and loyalty. In most of these dimensions personal relationship plays an
important part “…business relationships are established between companies,
and operated by people, or a group of people, so the social and psychological
aspect have great influence on the business relationships” (Gelei & Mandják
2011. 22. p.)

2. The role of personal relationship in business marketing

Besides the above mentioned ones several studies investigate the role of the
personal relationship during business to business relationships. Many consider
it as the most important binding force of business relationships. According to
the ARA model, published by the IMP Group, there are three basic forms of
the bonds between business partners: the activity links, the resources ties and
the social bonds, that refer to the personal relationships (Hakansson & Sneho-
ta 1995, Gelei et al. 2011). Also, studies in economic psychology analyse the
role of the personal relationship, as one aspect of embeddedness. Econom-
ic transactions cannot be described only in the aspect of economic motiva-
tion, but it must be analysed as embedded in social relationships (Granovetter
1985, Zukin & DiMaggio 1990). Personal relationship plays a significant part
in strengthening the relationship, as well as in factors like trust, commitment,
and loyalty. “…probably the most important role of the personal relationship is
that in long term relationships it almost chains together the participants during
encounters (exchanges)…”(Gelei & Mandják 2011, 28.p). The social bond de-
veloped in a relationship can reduce or even terminate the feat of self-interest
behaviour, which can raise the loyalty of the parties (Sommerfeld & Paulssen
2006). Several others draw the attention to the fact that business relationship is
often tied to a person, and not to the organization.

560
Interpersonal relationships can be so tight, that if a key staff member leaves the
organization it can lead to the loss of a part of the market share (Lindgreen et
al. 2000, Palmatier et al. 2007, Reynolds & Beatty 1999, Zolkiewski 2014). The
findings of Andersen and Kumar (2006) draw the attention to the fact, that the
absence of a positive personal relationship can block the development, or even
the maintenance of the relationship. Other authors’ findings show that personal
relationships can play a significant role in solving conflict situations (Gedeon et
al. 2009). Weitz and Bradford (1999) studying sales management, especially the
role of the personal selling, also come to the conclusion that at companies that
are seeking to establish a long term relationship, personal sales, namely the face
to face personal meetings play a significant role in solving conflict situations.
As we have seen above, there is a growing body of research that draw the
attention to the significance of the social embeddedness of business relation-
ships and interpersonal relationships and networks. In parallel to this the devel-
opment of information technology also affects the way business functions are
being organised. Information technology provides, among other things, new
ways and methods for business and personal communication, and relationship
management.

3. The role of information technology in business relationships

According to Zuboff (1985) companies might decide on using information tech-
nology in the pursuit of one of three goals: automation, information creation and
the transformation of business performance. In the early days of the spread of
information technology developments, the basic motivation was automation.
Companies expected financial and time benefits from the introduction of new
technology. The application of technology also greatly enhances the practice of
information creation. The information provided by the technology makes it pos-
sible to gain deeper knowledge of the processes; thereby the changes aimed at
increasing efficiency are able to reinforce the company’s competitive position.
Insofar as the information necessary for decision making and operation is avail-
able, the company’s aim can be to transform the activities and the business
performance and to take the opportunities becoming available by the usage of
information technology (Brady et al. 2002).
With the help of the increasingly more efficient and more user-friendly data-
base and information management (Holland & Naudé 2004) and the modern
communication methods, several subfields of organizational management
have become more efficient. Companies now can easily track their consumers’
ordering and purchasing behaviour and preferences in the long term, as well
as the extent of profit deriving from serving each customer, in order to perfect
their supply, formulate personalised offers to solve their customers’ problems or
deliver the product more efficiently to the customers based on this information.
Tong et al. (2008) studied the effect of information technology on inter-organ-
izational relationships, since the technology-based buyer-seller interface has

561
also emerged in organizational markets. Their research results have pointed
out that the intensive use of information technology can serve both transac-
tional and relationship approach. Therefore, in each situation it is important
to understand the application of the technology, because automation supports
transactional approach, while customer database and personalization supports
the use of relationship approach.
The results of information technology development have closely interwoven
with the evolution of marketing theory, thus today the terms of marketing ac-
tivities supported by different information technologies signify both technology
and marketing approach itself. Both in the business press and among scientific
sources we can find approaches according to which IT solutions rather than
support marketing and, at the same time, business activity, they fundamentally
change it, “raise it to a new level”.

4. Can IT enabled communication result a personal relationship

The research projects of the IMP Group completed in the past three decades
have led to the conclusion that one of the most important keys of business
relationship success is the relation of the participating organizations and the
development of interactions between these actors. According to the interaction
approach (Turnbull et al 2002), companies do not think in individual transac-
tions, but in most cases these transactions form a long-term relation, and each
transaction is only an episode of this relationship. However, in the course of the
episodes, relationships develop not only between organizations but between
involved persons as well, which has a significant role in ensuring the long-
term maintenance of the relationship. But business relationships do not exist
by themselves. The parties involved in the relationship have several relations
towards other actors and these relationships also can have serious effect on
the relation in question. Thus the dyadic relationship is none other than a slice
of the network of relations connected to and dependent on each other (Leek
et al 2000).
According to Hakansson (1982), market actors use both impersonal and per-
sonal communication methods for information exchange. They use imperson-
al communication methods to convey basic technological or commercial data
and personal communication methods to convey ‘soft data’ and information
(e.g. in connection with product use, developing cooperation). However, this
also seems to be changing with the spread of information technology solutions.
For instance, Naudé and Holland (1996) assume that a new kind of strategic
relationship can be formed with the help of IT-based technologies, since the
application of technological solutions enables a more rational decision making.
Information technology plays an important role in the buyer-supplier interaction
as well. What’s more researchers argue that these technology enabled inter-
actions are among the key factors of long term success (Meuter et al. 2000,
Coviello et al. 2001, Brady et al. 2002, Ryssel et al. 2004). The new IT enabled

562
communication and sales methodologies support the involvement of customers
in the value creation process as well. Owing to this, the traditional toolbox of in-
formation exchange completed in the course of the business process has also
changed. In their research, Leek et al. (2003) found that although according to
about half of the respondents, the use of information technology for communi-
cation decreases the significance of personal meetings and makes communi-
cation faster and more accurate, a similar proportion of the participants talked
about the alienation, impersonation of relationships, thus becoming task-orient-
ed at the same time. All this in turn can result in developing trust between part-
ners with more difficulty and managing uncertainties more slowly, moreover, in
a lower level of satisfaction.
We can see from the above summary that the results of the research approach-
es measuring the effect of information technology usage are diverse. More re-
search is needed to understand the impact of information technology on long
term relationships.

5. Primary research
During the past years (between 2010-2016) we conducted 5 research projects
to analyse the change in the importance of information technology enabled and
“face-to-face” interactions in business relationships.
Based on the results of our quantitative and qualitative research projects be-
tween 2010 and 2013, we decided to examine separately how the communica-
tion method influences the judgement of the quality of the relationships. In this
part we summarise the most important results and conclusions of the qualita-
tive research that was conducted between 2014 and 2016.

Research objectives
We formulated the following objectives in the course of our qualitative research:
• to analyse the role of IT enabled and personal meetings in business
markets;
• to analyse the effect of the communication and interaction methods on
the level of trust, commitment and loyalty;

Research methodology
In the course of this explanatory research 22 in-depth interviews have been
completed, where the representatives of large multinational and small- and
medium sized enterprises provided answers. The interviews were made be-
tween the autumn of 2014 and the spring of 2016. The respondents include the
representatives of manufacturing and service providing companies. From the
many aspects we examined during our research we focus on two in our present
paper: the effect of the form of communication method on trust, commitment
and loyalty, the characteristics of the usage of the communicational channels.

563
Results of primary research
The role of IT enabled communication and personal meetings in business
markets - Channels of communication
Respondents still seem to be uncertain about the role of information technology
in business relationships. The responses indicate that several aspects have an
effect on the method of communication being used.
Relationship lifecycle
“… My colleagues use e-mails especially frequently. Everyone uses smart
phone now. I always tell them that these technology based methods are not
enough, especially in the beginning phase, while trust is being built. In a new
relationship I am insistent on having at least one personal meeting with the
partner because it strengthens trust.” (Manager, business service provider)

Profile
“The first thing is to organise a personal meeting with a new partner even if
he approached us via e-mail. No offer is made until that. For the everyday
interactions we use phone that is the fastest. We do not use social media or
videoconferences to interact with our customers, we don’t need these, it is
not that industry.” (Representative, production equipment distributor)

Rules of procedure
“We have to interact with the partners in a controllable and verifiable way.
We have very strict regulations about customer interactions. There is no
place for being personal in these. Having a personal relationship with a
partner is considered to be a suspicious business in this company, but if you
keep all the regulations, you cannot get into personal relationship with the
representative of the partner organization.” (Representative, multinational
manufacturer)

Seller or buyer position

“As I see, sellers are more open to information technology while buyers
consider personal meetings more important.” (Representative, industrial
manufacturer)

Conflict situation
“Face-to-face communication is needed when there is a problem. I talk the
least to the person whom I am satisfied with. Because there is nothing to
talk about, no need to give directions, to tell him off, or ask for help. With
these good partners less personal channels, like e-mail come to the front.”
(Manager, wholesaler)

564
But an intuition might also have an influence on what method is being used.
“The mean of communication is defined by the situation in most cases. You
have to feel when you need a personal meeting. Many times a phone call
or email is enough if it is not that urgent or important.” (Representative, IT
service provider)

Based on these opinions we can conclude that combined usage of these com-
munication methods is the most frequent. Companies seem to be open to the
new technologies and communication channels, but personal meetings are
considered to be crucial. One can see from the above responses that the way
and channel of communication is largly affected by the situation.

Trust, commitment, loyalty

“… it is not always beneficial for the company to choose an unknown sup-
plier because they offer a few percent lower price. We had a problem with
that once. By the end it cost more because they did not deliver the way they
promised. The company vanished in about a year and we had to handle the
complains of the end users. After this we decided to cooperate only with
trustworthy, steady partners who offer good quality of products, services and
relationship.” (Representative, IT service provider)
“Having a personal relationship means that the partners know each other. In
this case communication involves what makes it personal regardless of the
channel of communication. But only the personal, face-to-face communica-
tion can establish the trust. But on the other hand, the new IT technologies
might nearly be ready for this.” (Representative, business service provider)
“The basis of the “success” of the relationship is the mutual satisfaction. It is
the basis of a long term relationship, and the trust that develops during that
time. Since we talk about companies, not the individuals are the essentials,
but good personal relationship can only spring up between individuals, so
that is why it is important too.” (Representative, business service provider)

Expectations for the future

The picture hasn’t changed compared to what we found earlier. The organisa-
tions know that the usage of information and communication technology is nec-
essary for the competitive advantage, but they don’t see a chance that these
technics would substitute personal meetings.
“..Although I am not a futurologist, but I am sure, that the changes happened
so far, and the established trend wouldn’t change in the future. The technol-
ogy developed, the communication method, the channel, the customer and
supplier behaviour also changed. I don’t know, what brings the future, but
we try to keep up. Slowly such independent communication and economical

565
 trends and sciences develop, which we can use to make profit. If we miss
our chances there will be no more profit that brings us further.” (Represent-
ative, IT service provider)

“…in the last few years the personal relationship, and the personal contact
has subsided, which is not good. I believe in personal relationships and
that a personal meeting brings much more than a super IT system. Within
the company there are a lot of communicational channels, but nothing can
replace that if you go over to the next door office and solve a problem per-
sonally” (Representative, industrial manufacturer)

“… the real business relationships doesn’t go anywhere, they will be direct

contacts between individuals for a long time” (Manger, retailer)

6. Quantitative research
6.1. Model development – constructions- definitions
personal relationship, personal encounter, IT communication
During the development of the research model on one hand we declare, what
we consider as important categories form the research’s point of view, on the
other hand we formulate the hypotheses.
The development of the information technology resulted in a number of new
tools and communication channels for interpersonal and business interactions
(Coviello et al. 2001). In this study we consider the IT based communication
as internet based, or other information and communication technology based
interaction between two person or corporation. While the personal encounters
(face to face actions: discussions, trainings, team meetings etc.) can be easily
defined the definition of personal relationship is more difficult since the digital
communication technology can also help maintaining personal relationships.
Because of the lack of consensus in the literature about the understanding of
personal relationship, we experienced difficulties in securing the validity of the
research model.
In our research, we concentrated on the personal relationships. Personal rela-
tionship is more than the personal encounter. It means regular and continual
communication between business partners. The channel of communication in a
personal relationship therefore may also be telephone or e-mail too. The main
point is that these communication acts should be interpersonal (representing
long lasting relationship between individuals).

566
Satisfaction
Satisfaction is considered as cognitive response (Bolton – Drew, 1991, Howard
– Sheth, 1969, Tse – Wilton, 1988), and emotional response (Cadotte et al.,
1987, Westbrook – Reilly, 1983) to expectations, in the literature. Since B2B
interactions form long lasting relationship in the most cases, satisfaction is not
single act either. It is a development procedure, where numerous other factors
play part in shaping the overall satisfaction, or dissatisfaction feeling (West-
brook, 1987, Fornell, 1992). During the episodes however relationship evolve
not only between the organisations, but also between the people taking part in
it, which plays an important role in securing the maintenance of a long lasting
relationship. According to research results of others, personal relationship can
play an important role in solving conflict situations too (Gedeon et al., 2009).
H1. Relationship satisfaction is affected positively by personal relationship.
The more and more efficient and user friendly database and information man-
agement (Holland – Naudé, 2004) together with the help of the modern com-
munication methods resulted in higher efficiency in a number of areas of the
organisation’s operation. Tong et al. (2008) studied the effect of the informa-
tion technology on the inter-organizational relationships, since the technology
based seller-buyer interface appear on the business market too. Their research
showed that the intensive usage of information technology serves not only the
transactional but also the relational approach. It is important therefore to get to
know the application of the technology. While the automation represents the
transactional approach, customer databases and customization supports the
relational approach.
H2. The information technology based communication has a positive
influence on relationship satisfaction.

Turst
Walter and Ritter (2000) describe trust as the belief in the trustworthiness and
competence of the partner. Trust therefore is such a dimension of the evalua-
tion of the relationship, which contribute to a stable, reliable cooperation in the
inter-organizational relationship. The first stage of trust is the preliminary trust
based on the perceived elements. The personal relationship usually strengthen
trust and so the relationship, so when the customers don’t err in trust, they are
longing for building a long term relationship (Singh - Sirdeshmukh, 2000, Voll-
mer et al., 2000).
H3a. The personal relationships have a positive effect on trust.
According to Hakansson (1982) the market actors use both the personal and
the impersonal communication methods for information exchange. For express-
ing basic technical or commercial information the impersonal, and for passing
“soft” data and information (e.g. product usage, forming of cooperation) the
personal communication methods are used. However with the spreading of
the information technology these methods seem to change also. Customers

567
become ever more part of the value creation process, through the new com-
munication and sales methods. The information technology plays an important
part in the business-customer interaction too, moreover some authors consider
these technology based interactions as the key factors of the long term success
(Brady et al., 2002)..
H3b. IT used for communication purposes has a positive impact on trust
through the satisfaction.

Commitment
Commitment can be defined as “permanent desire for maintaining an important
relationship”, and this can be considered as the antecedent of loyalty (Costa-
bile, 2000). Gundlach et al. (1995) discuss the three dimensions of commitment:
emotional commitment, which is a positive attitude for maintaining a future re-
lationship; instrumental commitment, which means a kind of investment during
the relationship (time, resources); and the third dimension is the dimension of
time, which means the confidence in the future existence of a relationship. In
the B2B relationships, commitment means a kind of psychological attachment.
One aspect of this is maintaining the personal relationships.
H4. Personal relationships have positive impact on the commitment.
The information ensured by technology enables the better understanding of the
processes, so the changes related to the enhancement of efficiency are able to
strengthen the company’s position in the competition (Brady et al., 2002). Leek
et al. (2003) in their research found that according to about half of the respond-
ents think that the usage of information technology for communication decreas-
es the importance of the personal encounter, and IT makes the communication
quicker and more accurate. The other half of the respondents report about the
drawing-away of the relationships, impersonalization, and thereby becoming
task oriented. Consequently, the development of trust between partners could
become more difficult and the handling of the uncertainty become slower. The
research results shown above are not convincing regarding the connection be-
tween IT and commitment so, in our model we assume that:
H5. The impact of IT used for communication purposes on commitment is
not measureable directly.

Loyalty
In our model we take loyalty as a result factor. We take it as the final link in-
dicating that partners are willing to repurchase and cross-purchase, they are
not price sensitive, and they recommend the partner for others wholeheartedly
(Grönholdt et al., 2000). Social bonds in relationships can decrease, or even
release the fear from self interest following behaviour, which increases the part-
ner’s loyalty (Sommerfeld – Paulssen, 2006). Several authors also draw the at-
tention to that business relationships are often connected to persons and not to
companies. The interpersonal relationship can be so strong, that an important

568
employee leaving the company can mean the loss of a market share (Lindgreen
et al., 2000, Palmatier et al., 2007, Reynolds-Beatty, 1999, Zolkiewski, 2014).
H6. Personal relationship has a positive impact on loyalty.
We found a number of research results in the literature showing that the satis-
faction strengthens trust, trust has a positive impact on commitment, and that
trust and commitment has a positive impact on loyalty, so we assume that:
H7a. Satisfaction has a positive impact on trust.
H7b. Trust has a positive impact on loyalty and commitment.
H7c. Commitment has a positive impact on loyalty.

6.2. Measurement, methodology

In the course of operationalizing the concepts included in the study, we relied
on the literature review and qualitative research conducted earlier. We also ap-
plied scales already validated other studies (Čater- Čater, 2010, Révész 2011).
Defining concepts and their items was done by principal component analysis.
The following concepts are included in our final model: personal relationship,
IT relationship, satisfaction (with items considering the satisfactin with the re-
lationship and with the product also), trust, commitment, loyalty. (We planned
to separate the items of personal meeting and personal relations; however, the
items are not separable based on the results of principal component analysis.
Therefore, personal relationship consits of items of personal meeting and items
of personal relations too.)
Our research was conducted between 1st of August and 30th of September in
2015 among social enterprises employing more than 2 employees. Sampling
and sending out the questionnaires carried out by the Hungarian Central Sta-
tistical Office. Results of 312 respondents were collected, which means a re-
sponse rate of 30%. The sample is considered to be representative from the
point of view of size of enterprises and regional distribution.
Testing the hypotheses requires the examination of the relations between latent
variables, for which PLS path analysis can be applied (Hair et al,, 2014), as the
variables (indicators) cannot be considered normally distributed (also in the
case of Kolmogorov-Smirnov and Shapiro-Wilk tests, p<0.01 for each variable).
We applied SmartPLS 3 (Ringle et al, 2015) software for PLS path analysis.

6.3. Results
With regard to the results of the outer (measurement) model, we examined the
reliability of the constructions with Cronbach’s Alpha (>0.7) indicator and CR
indicator (composite reliability>0.7), concerning which we find that criteria (Hair
et al, 2014) are fulfilled in the case of all constructions. For checking conver-
gent validity, we considered standardized factor loadings (>0.5), AVE (average

569
variance extracted, >0.5) indicators. Comparing minimal criterion values (Hair
et al, 2014) to the indicators, the existence of the six constructions can be
verified. For checking discriminant validity, HTMT ratio of correlations can be
applied (Henseler et al, 2015), which is lower for each variable pair compared
to the criterion value of 0.9. Based on the results of the outer model, the exist-
ence of latent variables can be proven; furthermore, the indicators related to the
given latent variables represent the same phenomenon.
In terms of the results of the inner (structural) model, the effects of IT relationship
on trust, on commitment, on loyalty are not significant; and personal relationship
has non-significant effect on trust either. After eliminating non-significant effect
from the model, all of the paths represent significant effects (Table 1).

Mean
Path
of path Standard
coefficient
Path coefficients error of t-value p-value
(original
(bootsrap the mean
sample)
samples)
IT_rel -> Satisfaction 0.130 0.156 0.047 2.760 0.006
Trust -> Commitment. 0.553 0.556 0.059 9.456 1,25*10-19
Trust -> Loyalty. 0.418 0.424 0.085 4.894 1,34*10-6
Commitment. -> Loyalt. 0.201 0.198 0.095 2.118 0.035
Satisfaction -> Trust 0.581 0.582 0.054 10.820 1,18*10-24
Personal_rel -> Commitment 0.269 0.266 0.063 4.295 2,1*10-5
Personal_rel -> Satisfaction 0.239 0.234 0.078 3.089 0.002
Personal_rel -> Loyalty 0.137 0.132 0.060 2.258 0.024

Table 1. Testing significance path coefficients

Source: own calculation

In the final model developed by taking account of the significant effects, in

terms of direct effects it can be established on the basis of the standardized
path coefficients in Figure 1 – on each arrow – that there is a positive effect be-
tween the latent variables in the case of every pairing. The following statement
can be formulated regarding standardized path coefficients (β):
-- Personal relationship has stronger effect (β=0,239) on satisfaction com-
pared to the effect of IT relationship (β=0,130).
-- Trust has stonger effect (β=0,553) on commitment compared to the ef-
fect of personal relationship (β=0,269).
-- Trust has the strongest effect on loyalty (β=0,418), followed by the ef-
fects of commitment (β=201) and personal relationships (β=0,137).

570
Figure 1. Effects of communication types on relationship success
Source: own construction

Based on the values in the ellipses in Figure 1, the total variances explained in
the model can be regarded as low in the case of satisfaction; but R2 in the case
of trust, commitment and loyalty are regarded as medium.
However, in the model it is worth mentioning the effect sizes between the vari-
ables based on the f2 indicator, which examines the change in the coefficient of
determination of an endogenous variable by omitting a given exogenous varia-
ble (Hair et al, 2014). The effect of satisfaction on trust (f2=0.508), and the effect
of trust on commitment (f2=0.525) can be considered strong. Furthermore, in
the case of the effect of trust on loyalty (f2=0.175), and the effect of personal
relation on commitment (f2=0.124) can be considered medium. Thus based on
the f2 indicators, a satisfaction – trust – loyalty, and a satisfaction – trust – com-
mitment path can be highlighted. Finally, decisions about the hypotheseses can
be seen in table 2.

571
 Hypothesis Decision
H1. Personal relationhip has a positive effect on satisfaction Accepted
H2. IT relationship has a positive effect on satisfaction Accepted
H3a. Personal relationship has a positive effect on trust Rejected
H3b. IT relationship has a positive effect on trust through satisfaction Rejected
H4. Personal relationship has a positive effect on commitment Accepted
H5. IT relationship has no direct effect on commitment Accepted
H6. Personal relationsip has positive effect on loyalty Accepted
H7a. Satisfaction has positive effec on trust Accepted
H7b. Trust has positive effect on loyalty and on commitment Accepted
H7c. Commitment has positive effect on loyalty Accepted

Table 2. Decisions about the hypotheses

Source: own construction

7. Summary, limitations of the study

Based on the results of data analysis we did not manage to prove the impact
of personal and the IT based relationship on the relationship success. Although
the way of the communication influences the judgement of the success, the
results are confusing. It can be seen that the analysed factors have only partly
effect on satisfaction, trust, commitment and loyalty. IT based relationship in-
fluences significantly only satisfaction, and the personal relationship influences
only satisfaction, commitment and loyalty significantly. Based on the f2 indi-
cators from our model the “satisfaction-trust-commitment”, and the “satisfac-
tion-trust-loyalty” path can be highlighted. It is also important to mention the
personal relationships effect on loyalty and its significant effect on commitment.
In the same time the research result also show, that in the research model it is
necessary to clarify the differences between the personal relationship and the
personal encounter, in order to secure the validity. We also have to clear how
big influence the information technology has on interpersonal encounter during
interactions. Another limitation of the research seems to be the domestic sam-
pling: in an international comparison most probably we would find even more
striking/surprising results than that above, due to the cultural defences and the
differences in the level of used modern technology.

8. Summary, conclusions
The results of the empirical research show two, seemingly inconsistent, but
in the everyday practice existing forms of handling relationships. We can con-
clude that the advantages of the information technology have their effect on the
business to business relationships. Moreover, based on the interviews it seems

572
that the role of the IT is significant, especially during the interactions with the
customers, at least considering the frequency of the interaction. In nowadays
business world it is necessary for the companies that they quickly and efficient-
ly exchange information, they continuously interact, and instantly react. At the
same time it can be seen, that the personal interactions, the personal contacts
will still be essential in the future, especially at new project, or at conflict situ-
ations. In most cases our results show that personal meetings and IT enabled
communication does have its role in business relationships. Companies seem
to combine these ways of communication. A number of characteristics have
been identified in our research that has an effect on the choice of communica-
tion channel. The stage of the relationship lifecycle, the industry the companies
are involved in, the company rules and procedures, the seller or buyer role itself
and the presence of conflict seem to be the factors that are considered by the
actors in a relationship.
Important result of our research is that personal relationships have outstanding
role in strengthening trust, so the personal relationships still can be considered
as a pledge of long term relationships. Based on our findings we think that both
ways of handling relationships have their effect on the relationships between
businesses: the acceptance and usage of IT is necessary, but it cannot sub-
stitute the milieu, that can be felt during a personal encounter. It seems that in
relationship between businesses IT and the personal encounter serve together
the efficiency of the relationship.

573
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 PART 9

MONETARY POLICY IN ERA OF DIGITAL CURRENCIES

 CHAPTER 33

Asymmetric price transmission in Croatia within

the real estate market

Zdravko Šergo1, Jasmina Gržinić2

ABSTRACT

Croatia has experienced a huge volatility, expressed in rapid growth, fall, stagnation
and revival of the real estate market in recent decade. The City of Zagreb has the most
transactions in real estate business and the Adriatic Coast participate as second in mar-
ket share. This study is an attempt to test the relationship between the price indices of
real estate, in those two regions, over the 2006M6–-2016M3 period. For this purpose,
we have chosen the threshold cointegration and an asymmetric error correction model
approaches. Some of these regions have been the price leader of the market and its
price has been evolving more independently. Whether it is due to swelling demand for
dwelling, stimulated by thriving tourism industry that priority gives to Adriatic or acces-
sion of Croatia to the European Union that gives advantage to capital city will be tested
by Granger-causality test. In this paper it is assumed that the transmission between the
prices of those regions has been asymmetric in both the long term and short term.

Key words: Price, Real estate, Threshold cointegration, Asymmetric ECM,

Croatia

JEL classification: E31, E37, R31, R32, C32

1. Introduction
For some reason, in the late 1990s and early 2000s the idea that homes and
apartments were spectacular investments gained a strong-hold on the public
imagination, in the United States and in many countries as well. Not only did
prices go up, but there was palpable excitement about real estate investments
(Akerlof & Shiller, 2009). There are two reasons for that excitement in Croatia
in the last decade. First, the convergence of accession of Croatia to the Euro-
pean Union, the rising liberalization of EU market, the right of EU residents to

1 PhD, Senior Research Associate, Institute of Agriculture and Tourism Poreč, Karla Huguesa 8,
52100 Poreč, Croatia. Scientific affiliation: macroeconomics and applied econometrics, economic
growth. Phone: +385 52 408 300. Fax: +385 52 431 659. E-mail: zdravko@iptpo.hr (corresponding
author)
2 PhD, Associate professor, University Jurja Dobrile in Pula, Faculty of Economics and Tourism
“Dr. Mijo Mirković“, 52100 Pula, Croatia. Scientific affiliation: tourism development, international
tourism, touroperators and travel agencies. Phone  : +385 52 377 029. Fax: +385 52 216 416.
E-mail: jasmina.grzinic@unipu.hr

579
acquire real estate in EU member states, the well-development of a mortgage
supply capital provided by mainly Austrian, German and Italian banks, all that
were impacted in boosting prices. Second, substantial cohort of baby boom-
ers non-residents nearing retirement age have haste to invest their savings in
rental property assets in Croatia that appear to provide more secure cash flow.
They are thought, the house can be rented or if things go wrong sold for specu-
lative reason. Namely, real estate may bring, greater benefit than investment in
a motor home, for example. The trend towards living in capital city apartments,
caused by inter country migration, has boosted construction activity in Zagreb,
whereas the growing attractiveness of coastal property has increased costal
property values in Adriatic region, in the meanwhile
The prices of commercial real estate and of homes and condominiums have
prior 2007 (in Zagreb) and 2009 (in Adriatic region) had inflated and become
bubble-like. Prior to the burst of the bubble in Zagreb city region and the result-
ing real estate crash that began in earnest in 2007, historical housing price data
from the Burza Nekretnina seemed to support the theory of endlessly rising
prices in capital city of Croatia. Although, real estate prices in Croatia in last
decade are as volatile as overall economic performance in the country. The
same had been true for Adriatic, the well know tourist destination. By 2008, real
estate prices in Adriatic region data showed just a slight increase. Unfortunate-
ly for native homeowner sellers in Adriatic region, 2009 was the last year of
healthy growth before the market collapsed. After that, the prices experienced
an unprecedented decline (about 27% within 2007-2015). Consequently, real
estate price deflation has become a serious threat to the domestic construc-
tion industry and aroused wide concerns among entrepreneurs in the Croatia.
Before the economic crisis (2005 – 2008) the average is built 10545 buildings
per year and 23 273 flats, but in times of crisis (2009 – 2015) these numbers
dropped to 6300 buildings with 11978 flats with simultaneous the fall of the sur-
face of the building for 44.1% and the area of the flats for 44.7% (HGK, 2016).
As real estate price de-accelerates, the recession has changed considerably
Croatia’s market over the last decade. Yet, by mid-2016, housing prices in Adri-
atic region had risen back to 2009 last year peak level. From 2015 on, the real
estate market for the first time noticed slightly recovery, signalled by 0.3% in-
crease in house prices and expanded construction activity measured by issued
licenses at national level.
Up to now it has been hinted that the prices of a real estate in two main sta-
tistical regions of Croatia had specific dynamics and trajectory path per se.
Yet, their paths are not independent one from another, and in this paper we
will show it. Real estate prices in the Adriatic region until the year 2002 were
lower than the prices in Zagreb and the rest of Croatia. After 2007, the position
is completely opposite: real estate in the Adriatic become costlier than that in
Zagreb and in the rest of Croatia. Such a development is a consequence of
the intensive growth of real estate prices on the coast where they had grew
up in the period of 1997 - 2008 in cumulative by 167 percent (or indeed an

580
impressive 14 percent a year) that would have reached an average price from
1,925 euros per m2 during 2008. At the same time, in Zagreb in the same pe-
riod, property prices recorded a growth of 78 percent (two times less than of
coastal side of Croatia), and in the rest of Croatia, only 50 per cent. An intensive
growth of prices was a result of the strong domestic and foreign demand for
real estate on the coast, the limited supply of real estate items, but also specu-
lation related to the further strengthening of the demand side once Croatia after
access to the European Union, enable their nationals the purchase of real es-
tate (Vizek, 2010). Land-price bubbles were often justified by the logic that an
ever-growing population (in case of Adriatic augmented by inflow of foreigners
combined with a limited supply of land is sure to make land scarce and houses
that lay into that land parcels precious and expensive.
Croatian real estate sector has experienced significant structural changes in
recent decade. Such changes have influenced price dynamics and transmitted
shocks to the real estate markets, especially on the two main markets of the
regions within the country.
Exposed information, so far, give us the right to emphasize our main hypoth-
esis, that the Adriatic region is a price leader in transmitting those shocks on
Zagreb real estate market. But, what is the relationship between these two
market prices is really unknown without deep statistical analysis. Which market
is the leading one to reflect information into the market prices, will be tested by
Granger causality test?
This paper investigates price transmission mechanism in the real estate busi-
ness between two markets especially on the two main markets of the regions
within the country (Adriatic & Zagreb) using monthly price data for the period
2006.03 to 2016.5. Price transmissions, market integration and price leader-
ship in real estate have been missing in relevant literature to help understand
price interaction and dynamics in case of Croatia. Asymmetric Price Trans-
mission (APT) has received considerable attention in the literature because
price transmission may differ according to whether prices are increasing or
decreasing in two regions. Given the evolution of the real estate markets in both
Croatia’s regions and the current status of empirical analyses of price transmis-
sion, the objective of this study is to examine the dynamics between the real
estate prices of from Zagreb and Adriatic. The latest error correction model with
threshold cointegration is employed for the price analysis. At the beginning,
linear cointegration analyses, including Johansen and Engle-Granger two-step
approaches, are applied to evaluate the cointegration relationship. The latter
analysis would provide intuition about the price leadership of one of these two
markets. Then the analysis is extended to nonlinear threshold cointegration. At
the end, an asymmetric error correction model with threshold cointegration is
utilized to analyze the short-term relationship.
The rest of the article is organized as follows. In the second section, a review
of the literature is presented. The emphasis is on housing price transmission

581
paper contributions in the last decade. In the third section, the methodology em-
ployed is presented, including the linear and threshold cointegration approach-
es and the asymmetric error correction model. Following that, the data used
and the empirical analysis are presented. The next chapter will address results
with short discussion. Finally, the section concludes with closing remarks.

2. Literature preview
Past studies have shown that changes in the house price of a region may trans-
mit to its neighboring regions. The transmission mechanism may follow spa-
tial and temporal diffusion processes (Nanda and Yeh, 2014). In theory, we
do know that the relationship between the local population and holiday home
owners exhibits secondary elements of conflict, since the two groups share an
implicit social pact (Bimonte and Punzo 2007); however, a trade-off between
tourists and local residents may arise when the high demand for holiday homes
by the former inflates real estate prices at the disadvantage of some of the lat-
ter. In paper dealing with residents’ perceptions of the socio-cultural impacts of
tourism at Lake Balaton, Hungary: negative impacts embodied in costs of land
and housing is perceived to be very high, overtopping other negative percep-
tion of tourism externalities (like, residents’ concern for material gain, conges-
tion, crime, prostitution, gambling, vandalism, drug abuse, alcoholism, sexual
permissiveness etc. (Ratz, 2000).
The study of Tsai et al (2016) investigates the determinants of tourism real es-
tate prices, with an emphasis on the impact of theme parks. A hedonic pricing
model was built using a sample of 294 real estate transactions in the Overseas
Chinese Town area of Shenzhen, China. Findings indicated that while distance
to metro and the architectural features of the property itself had significant pos-
itive effects on tourism real estate value, distance to theme parks was found to
have a negative effect on price. Itzhak (2011) investigating the case of Illinois (in
2005-2008) during the housing boom, state that financially constrained home
buyers artificially inflated transaction prices in order to draw larger mortgages.
Property prices in areas with a high rate of past price inflation exhibited momen-
tum and high volatility. Because of the dual motives to purchase a home, most
economists do agree that housing demand is best measured as home price
rather than home size. The recent housing boom in the United States, however,
dramatically inflated home price and widely increased housing costs (Di, 2010).
Reviewing more recent literature about price transmissions, market integration
and price leadership in regional real estate market, we do see rare, but inspiring
positive contributions of othersˈ work.
The work of Yang et al (2013) examine dynamic relationships among housing
prices from four first-tier cities in China from December 2000 to May 2010 and
present an equilibrium model of housing price in multi-markets with long-run
equilibrium relationships and important short-run dynamics and price structures
such as price leadership, price transmission lag and asymmetric price responses.

582
They conclude that the revealed effective price transmission and high correla-
tion among these different markets in China is not a good thing for a stable fi-
nancial system and for the defense against price bubbles in the housing market.
Another papers explored the relationship between housing prices and trans-
mission mechanism in broader range with different topics. Yuksel (2016) based
research on the relationship between stock and real estate prices focuses on
two transmission mechanisms, namely the wealth and credit-price effects. The
paper uses the 2007 global financial crisis as a natural experiment and exam-
ines whether the relationship between real estate prices and stock prices has
changed after the outbreak of the crisis by using data from the Turkish market.
The results based on a threshold cointegration framework indicate that while
both effects exist during the pre-crisis period, only a credit-price effect is ob-
served during the crisis period.
In similar venue, using the non-parametric rank tests proposed by Breitung
(2001), authors in their paper (Su et al, 2013) try to determine whether non-lin-
ear long-run equilibrium relationship exists between the stock and real estate
markets of China. They also adopted the threshold error-correction model
(TECM) and find the existence of a long-run non-linear relationship between
the Shenzhen composite index and the real estate price index. They conclude
that a bi-directional feedback causal relationship among the wealth and cred-
it-price effect exist within those markets.
The paper written by Blake & Gharleghi (2018) investigate the Ripple Effect of
house prices at an inter-suburban level of analysis in the Sydney metropolitan
area and price transmission in order to improve residential real estate purchas-
ing decisions of market participants. In this paper Granger-causal pathways
were subsequently mapped for each suburb string identifying price transmis-
sion pathways and confirming support that while the standard Ripple Effect
does not exist at an inter-suburban level, it is still possible to predict price move-
ments by considering the price behavior of surrounding suburbs.
From an econometric perspective, authors (Marquez et al, 2014) estimate the
asymmetries in the consumption response within the momentum threshold
autoregressive model (M-TAR) proposed by Enders and Siklos (2001). The
same advanced technique is used in this paper. They find the existence of an
asymmetric behavior in the US aggregate consumption spending responses to
real estate wealth and credit market shocks, which is only significant when a
negative shock takes place.

3. Methodology
3.1. Linear cointegration analysis
The focus variables in this study are monthly real estate prices for two main
regions in Croatia — Adriatic costal region and Zagreb. As usual, their prop-
erties of nonstationarity and order of integration can be assessed using the

583
Augmented Dickey–Fuller (ADF) Test (Dickey and Fuller, 1979). If both the price
series appear to have a unit root, then it is appropriate to conduct cointegration
analysis to evaluate their interaction. Econometric literature proposes different
methodological alternatives to empirically analyze the long-run relationships
and dynamics interactions between two or more time-series variables. The
most widely used methods include the two-step procedure of Engle and Grang-
er (1987) hand the full information maximum likelihood-based approach due to
Johansen (1988) and Johansen and Juselius (1990). The Johansen approach
is a multivariate generalization of the Dickey–Fuller test (Johansen, 1988; Jo-
hansen and Juselius, 1990). It concentrates on the relationship between the
rank of a matrix and its characteristic roots in a vector autoregression. The
Johansen approach starts with a vector autoregressive model and then refor-
mulates it into a vector error correction model as follows:

where Xt is a vector of the real estate price at month t for Zagreb (Zt) and for
Adriatic region (At), K is the number of lags, and 𝓔t is the error term. The re-
lationship among the coefficients for the two equations is �i = -I + �j=1 i
πj and
Π = -I + � h=1 πh, where I is an identity matrix. Two types of tests, i.e., the trace
K

and maximum eigenvalue statistics, can be used to detect the number of coin-
tegrating vectors, r, among the variables in Xt.
The Engle-Granger two-stage approach focuses on the time series property of
the residuals from the long-term equilibrium relationship (Engle and Granger,
1987). For this study, it can be expressed as:

where and are coefficients, is the error term,

is the estimated residuals, Δ indicates the first difference, is a white
noise disturbance term, and P is the number of lags. In the first stage
of estimating the long-term relationship among the price variables
Zt and At, the price of Adriatic is chosen to be placed on the right side and
assumed to be the driving force. This considers the fact that Adriatic has been
the leading region in the stimulating real estate price (and that due to strong
demand for touristic apartment) for most years over the study period from 2006
to 2016. In the second stage, the estimated residuals are used to conduct
a unit root test (Engle and Granger, 1987). The number of lags is chosen so
there is no serial correlation in the regression residuals. It can be selected using
the Akaike Information Criterion (AIC), Bayesian Information Criterion (BIC),

584
or Ljung–Box Q test. If the null hypothesis of ρ= 0 is rejected, then the residual
series from the long-term equilibrium is stationary and the focal variables of Zt
and At are cointegrated. But if the null hypothesis of ρ= 0 is accepted we should
try to proceed with the same procedure analysis based on modified equation
expressed as:

which will hint that Zagreb market is the leading one to reflect information into
the market prices of Adriatic market.
Our choice of dependent and explanatory variable should ideally be determined
by the theory underlying regression given by Eq.2, which says that Adriatic
market is a price leader. But this assumption is based on economic intuition and
not on statistical rigorous test. In this case it may not be clear-cut or there may
be bi-directional causality, eventually. Based on statistical results we allow that
region of Zagreb could be price leader.

3.2. Threshold cointegration analysis

Suppose that Zt and At are unit root processes. To examine whether they have
an asymmetric cointegrating relationship, Enders and Siklos (2012) propose
the following two-step method. First, the linear cointegration model (2a) and/or
(2b) is estimated. Second, a two-regime threshold model is estimated for the
estimated residual , given by

where and are coefficients; p is the number of lags; is assumed

to be white noise and It is an Heaviside indicator function defined as

Variable is the so-called threshold variable with two alternative definitions

considered. For the first case, the threshold variable is defined as the level of
lagged residuals, that is, and the model is called the threshold au-
toregressive (TAR) cointegration model; in the second case, the threshold var-
iable is defined as the change in lagged residuals, that is, and
the model is called the momentum threshold autoregressive (MTAR) cointegra-
tion model, in which the series exhibits more ‘momentum’ in one direc-
tion than the other. The TAR model is designed to capture potential asymmet-
ric deep movements in the residuals (Enders and Granger, 1998; Enders and
Siklos, 2001), while the MTAR model is powerful to deal with steep variations
in the residuals, so it is especially valuable when the adjustment is believed to

585
exhibit more momentum in one direction than the other, according to several
studies (Chen and Zhu, 2015; Sun, 2011). Negative deepness (i.e., ) of
the residuals implies that increases tend to persist, whereas decreases tend to
revert quickly towards to equilibrium (Enders and Granger, 1998).
The threshold value τ can be specified as zero, given the regression deals with
the residual series. In addition, it is endogenously set by following Chan’s search
(1993) method for obtaining a consistent estimate of the threshold value.
Given these considerations, a total of four models are entertained in this paper.
They are TAR — Eq. (5a) with τ=0; consistent TAR — Eq. (5a) with τestimated;
MTAR — Eq. (5b) with τ=0; and consistent MTAR — Eq. (5b) with τestimated.
Since there is generally no presumption on which specification is used, it is rec-
ommended to choose the appropriate adjustment mechanism via model selec-
tion criteria of AIC and BIC (Enders and Siklos, 2001). A model with the lowest
AIC and BIC will be used for further analysis.
Based on Equation (2a) and/or (2b), we examine the asymmetric cointegrating
relationship by testing . Theoretically, if the null hypothesis is
rejected, one could conclude that there exists a cointegration of either symmet-
ric or asymmetric form (Cai, et al, 2011). In the
first test an F-test is employed to examine the null hypothesis. The test statistic
is represented by Φ. This test does not follow a standard distribution and the
critical values in Enders and Siklos (2001) should be used. If the null hypothesis
of no cointegration is rejected, a standard F-test can be employed to evaluate
the null hypothesis of symmetric adjustment in the long-run equilibrium, with the
null hypothesis given as
Rejection of this null hypothesis indicates the existence of an asymmetric ad-
justment mechanism.
It is well known that, if all considered variables are cointegrated, and then there
will be a corresponding ECM, for the Granger representation theorem (see Eng-
le and Granger, 1987). The result could be extended to threshold cointegration.
The specification assumes that the adjustment process due to disequilibrium
among the variables is symmetric. Two extensions on the standard specifica-
tion in the error correction model have been made for analyzing asymmetric
price transmission. Granger and Lee (1989) first extend the specification to the
case of asymmetric adjustments. Error correction terms and first differences
on the variables are decomposed into positive and negative components. This
allows detailed examinations on whether positive and negative price differenc-
es have asymmetric effects on the dynamic behavior of real estate prices. The
second extension follows the development of threshold cointegration (Balke
and Fomby, 1997; Enders and Granger, 1998). When the presence of threshold
cointegration is validated, the error correction terms are modified further.

586
That is to say, if Zt and At are threshold cointegrated, then we could construct
the following asymmetric ECM:

(6a)

(6b)

where ΔA and ΔZ are the real estate prices of Adriatic and Zagreb region in first
difference, θ, δ, α and β are coefficients, and ϑ is error terms. The subscripts A
and z differentiate the coefficients by region, t denotes time, and j represents
lags. All the lagged price variables in first difference (i.e., ΔZt-j and ΔAt-j) are
split into positive and negative components, as indicated by the superscripts
+ and –. For instance, is equal to (Zt-1 – Zt-2) if Zt-1 > Zt-2 and equal to 0
otherwise; is equal to (Zt-1 – Zt-2) if Zt-1 < Zt-2 and equal to 0 otherwise.
The maximum lag J is chosen with the AIC statistic and Ljung–Box Q test so the
residuals have no serial correlation. The error correction terms E, defined as
and are constructed from the threshold
cointegration regressions in Eqs. (4), (5a), and (5b). The former definition of the
error correction terms, according to Sun (2011) not only considers the possible
asymmetric price in response to positive and negative shocks to the deviations
from long-term equilibrium, but also incorporates the impact of threshold cointe-
gration through the construction of Heaviside indicator in Eq. (5a) and (5b).
Based on the results of the ECMs, we conduct some hypothesis testing. Note
that the real estate price of Adriatic region is assumed to be the driving force
and the long-term disequilibrium is measured as the real estate price spread
between Zagreb and Adriatic. Thus, the expected signs for the error correction
terms should be positive for Adriatic (i.e., ) and negative for Za-
greb (i.e., ).
The hypothesis that the Adriatic retail price Granger-cause its own price or the
Zagreb retail price can be tested, by imposing the following restriction on the
parameters of Equation 1, and then employing a F-test ( for
all lags i simultaneously). Similarly, the test can be applied to the Zagreb retail
price ( for all lags). The second type of hypothesis is con-
cerned with the distributed lag asymmetric effect. At the first lag, for instance,
the null hypothesis is that the Adriatic price has symmetric effect on its own
price or the Zagreb price ( ). This can be repeated for each lag and
both regions (i.e., ). The third type of hypothesis is cumulative

587
asymmetric effect. The null hypothesis of cumulative symmetric effect can be
expressed as for Adriatic region and
for Zagreb region. As last, the equilibrium adjustment path asymmetry can be
examined with the null hypothesis of for each equation estimated.

4. Empirical data and analysis

4.1. Data
The data for this study comes from Croatia Real Estate Price Index developed
by the Burza Nekretnina (real estate on-line portal), which is the first housing in-
dex system in Croatia. It is the most authoritative databank with the most com-
prehensive and detailed information on the Croatia property market covering
Zagreb, Adriatic and rest of the Croatia. The CREPI real estate price index re-
flects price movements on a monthly basis of repeating sales on housing mar-
ket. This article uses the real estate price index from May 2006 to March 2016
for two regions (Adriatic and Zagreb) for a total of 119 observations. Namely,
the starting and the end period reflect state of data availability when the data
are collected.

4.2. Descriptive statistics and unit root test

The descriptive statistics for the real estate prices of Zagreb and Adriatic are
reported in Table 1.

Item Zagreb level Zagreb diff Adriatic level Adriatic diff.

Mean 102.188 122.470
St.dev 8.904 7.281
Min 88.3 100.0
Max 116.603 137.030
Obs.no 119 119
ADF with trend -1.982[1] -6.254[1]*** -3.081[1] -6.554[1]***
ADF with drift -0.508[1] -6.28[1]*** -2.256[1] -6.654[1]***
Table 1. Descriptive statistics and unit root test results for the CREPI price index of
Zagreb and Adriatic region
Notes: The critical values are−3.99, -3.43, and−3.13 for ADF test with trend, and−3.46,
-3.14, -2.57 for ADF test with a drift at the 1%, 5%, and 10% level, respectively (Enders,
2004). The numbers in the bracket are lags used in the test.
*** Denotes significance at the 1% level.

Figure 1 displays the time series plots for the two CREPI indices. We can make
three observations: (1) Jad- and Zag-real estate price indexes have an evi-
dent comovement in general, which reveals a high possibility of cointegration
between these two series. (2) Although two indices move together most of the

588
 time during our sample period, they also display divergent movement indicating
possible nonlinear cointegration. (3). At the same time, the real estate pric-
es value from Adriatic has grown steadily and has passed that from Zagreb
since December 2006 (Fig. 1). Notice that for Adriatic real estate market, pric-
es continued to rise until the year of 2009 and reach a peak in September of
2009, which was affected by great financial crisis and prevailing pessimism of
potential apartment buyers afterward. In case of Zagreb the prices begin to de-
teriorate, much earlier, since free fall begin from Jun of 2007. Some summary
statistics about these two indices are reported in Table 1. We find that the aver-
age price of the Adriatic real estate price index (122.470) is substantially higher
than that of the Zagreb index (102.188), confirming what we saw in Figure 1.
The average values of the both indexes coincide approximately with the value
occurring in December 2010 (see Figure A1 & A2 in Apendices). The standard
deviation of the prices of the Zagreb real estate price index is higher than that
of the Adriatic, indicating a higher volatility in the Zagreb real estate market. The
correlation coefficient is 0.44 between the two prices over the whole study pe-
riod. The nonstationary properties of these two series are examined using the
augmented Dickey– Fuller (ADF) test (Dickey; Fuller, 1979). Using that test,
two different cases are considered: the case with drift, as well as the case with
trend. The optimal lags are determined by Akaike Information Criterion (AIC).
As reported in Table 1, the statistics reveal that unit roots cannot be rejected at
the 1% level for the level forms of both the price variables but rejected for the
first difference form. Thus, it is concluded that both the real estate prices for
Zagreb and Adriatic are integrated of order one.

Figure 1. Monthly real estate prices indices from Zagreb and Adriatic (May. 2006–March. 2016)
Source: Author’s computation

589
4.3. The linear cointegration analysis
Linear cointegration analyses are conducted using both the Johansen and En-
gle-Granger approach. Such traditional approaches require the same order of
integration for finding a long-run relationship among the variables. Based on
the lowest AIC and BIC, five lags are used in the regression when implement-
ing Johansen approach. Without prior information, three model specifications
with trend, constant, or no intercept are entailed (Table 2). For instance, with
only a constant included, the Johansen maximum eigenvalue statistic (λmax)
is 17.066 for the null hypothesis of no cointegrating vector between the prices
of Zagreb and Adriatic. This is significant at the 5% level (our rule-of-the-thumb
threshold) so the null hypothesis is rejected. However, for the null hypothesis
of one cointegrating vector, the λmax statistic decreases to 6.23, which is not
significant at all. Thus, the maximum eigenvalue statistic concludes that there
is one cointegrating vector. Similarly, the Johansen trace statistic also supports
the conclusion that the prices of Zagreb and Adriatic are cointegrated.

Critical value
Test Specification Lag Statistic 10% 5% 1%

Johansen
r=1 trend 5 11.39* 10.49 12.25 16.26
r=0 trend 5 24.914*** 16.85 18.96 23.65
r=1 const 5 6.23 7.52 9.24 12.97
r=0 const 5 17.066** 13.75 15.67 20.2
r=1 none 5 1.538 6.5 8.18 11.65
r=0 none 5 14.755* 12.91 14.9 19.19

Johansen
r=1 trend 5 11.39* 10.49 12.25 16.26
r=0 trend 5 36.303*** 22.76 25.32 30.45
r=1 const 5 6.23 7.52 9.24 12.97
r=0 const 5 23.297** 17.85 19.96 24.6
r=1 none 5 1.538 6.5 8.18 11.65
r=0 none 5 16.293* 15.66 17.95 23.52

Table 2. Results of the Johansen cointegration tests on the CREPI price index of Zagreb
and Adriatic region
Notes: r is the number of cointegrating vectors. The critical values are from Enders (2004).
* Denotes significance at the 10% level.
** Denotes significance at the 5% level.
*** Denotes significance at the 1% level.

590
Engle and Granger suggested the following simple two-step estimator. In the
first step, the long-term relationship between the real estate prices of Adriatic
and Zagreb is estimated, as specified in Eq. (2). The statistic from the unit root
test is -3.25 and it is significant at the 10% level. Yet, which alerts that the sig-
nificance is weak. We cannot conclude that the Engle-Granger approach also
confirms that the real estate prices of Adriatic and Zagreb are cointegrated
(according to Eq.2), because the weak integration among those variables. In
other words, assuming uni-directional causality, the Engle-Granger two step
methodologies requires that the residual from the regression in levels (first
step) be stationary - otherwise the second step is meaningless. Since cointe-
gration according Engle and Granger was not proven in regard to the Eq. (2)
we continue to test an Eq. (3) by reversed sides of two variables. The estimate
for the coefficient on the Zagreb real estate price (i.e.,α1) is 0.391with a p-val-
ue of 0.000. In the second step, the residual is used to conduct a unit root test
with the specification in Eq. (3). As reported in Table 3, the AIC and Ljung–Box
Q statistics indicate that one lag is sufficient to address the serial correlation.
Now, the statistic from the unit root test is -0.088 and it is significant at 5%. This
step of the analysis proves that the Zagreb is the leader that reflects prices on
the Adriatic market, although contrary to our theoretical considerations.

4.4. The error correction model analysis

The nonlinear cointegration analysis is conducted using the threshold autore-
gression models. Four models (i.e., TAR, MTAR and their consistent counter-
parts) are examined and the results are reported in Table 3. In selecting an
appropriate lag to address possible serial correction in the residual series, a
maximum lag of 12 is specified and tried at the beginning. Diagnostic analyses
on the residuals through AIC, BIC and Ljung–Box Q statistics all reveal that a
lag of three is sufficient.

591
 Engle- Consistent Consistent
Item TAR MTAR
Granger TAR MTAR
Estimate
Lag 3 3 3 3
Treshold † 0 3.177 0 0.654
0.088** -0.002 0.005 -0.026 0.02
𝜌1 (-3.41) (-0.061) (0.119) (-0.795) (0.63)
-0.1* * * -0.101* * * -0.11* * * -0.124* * *
𝜌2 (-3.073) (-3.183) (-2.789) (-3.495)
Diagnostics

AIC 437.975 426.372 425.759 427.238 423.767

BIC 446.313 442.841 442.229 443.708 440.236
QLB test(4) 0.284 0.826 0.813 0.89 0.845

QLB test(8) 0.263 0.929 0.922 0.913 0.922

QLB test(12) 0.135 0.844 0.868 0.721 0.742

Hypotheses

4.746 5.065* 4.297 6.114*

3.443* 4.049** 2.591 6.042**

[0.066] [0.047] [0.121] [0.016]

Table 3. Results of the Engle-Granger and threshold cointegration tests

Notes: † For the Engle-Granger cointegration test, ρ1 refers to ρ in Eq. (3). For the
Engle-Granger cointegration test, the critical value is −3.067, -3.368, and −3.964 at the
10%, 5%, and 1% level, respectively (Enders, 2004). TAR refers to the threshold au-
toregressive model and MTAR is the momentum threshold autoregressive model. QLB
(p) denotes the significance level for the Ljung-Box Q statistic; it tests serial correlation
based on p autocorrelation coefficients (p=4, 8, 12). Φ is the threshold cointegration
test with the critical values from Enders and Siklos (2001). F is a standard F-test on
the asymmetry of the price transmission and the numbers in the brackets are p-values.
* Denotes significance at the 10% level.
** Denotes significance at the 5% level.
*** Denotes significance at the 1% level.

592
In estimating the threshold values for consistent TAR and MTAR, the method
by Chan (1993) is followed. It turns out that different lag specifications in the
models have little impact of the final threshold values selected. The variation of
the sum of squared errors by threshold value for consistent MTAR with a lag of
three is presented in Fig. 3. The whole range of Δ is from -1.063 to 1.411. Around
the values of 0.51 zero and 0.63, the sum of squared errors is relatively low. The
lowest sum of squared errors for the consistent MTAR model is 241.685 at the
threshold value of 0.654. Similarly, the best threshold value with the lowest sum
of squared errors is estimated to be 3.177 for the consistent TAR model. Finally,
while the four nonlinear threshold cointegration models have similar results (Ta-
ble 3), the consistent MTAR model has the lowest AIC statistic of 423.767 and
BIC statistic of 440.236, and therefore, is deemed to be the best.
Focusing on the results from the consistent MTAR model, the F-test for the
null hypothesis of no cointegration has a statistic of 6.114, it is weakly signifi-
cant at the 10% level. Thus, the real estate prices of Adriatic and Zagreb are
cointegrated with threshold adjustment. Furthermore, the F statistic for the null
hypothesis of symmetric price transmission has a value of 6.042 and it is also
significant at the 5% level. Therefore, the adjustment process is asymmetric
when the prices of Adriatic and Zagreb adjust to achieve the long-term equilib-
rium. The point estimate for the price adjustment is 0.02 for positive shocks and
-0.124 for negative shocks. Positive deviations from the long-term equilibrium
resulting from increases in the Adriatic price or decreases in the Zagreb price
( ) are eliminated at 2% per month. Negative deviations from the
long-term equilibrium resulting from decrease in the Adriatic price or increas-
es in the Zagreb price ( ) are eliminated at a rate of 12.4% per
month. In other words, positive deviations take about 4.16 years (1/0.02=50
months) to be fully digested while negative deviations take 0.8 months only.
Therefore, there is substantially slower convergence for positive (above thresh-
old) deviations from long-term equilibrium than negative (below threshold)
deviations.

4.5. The threshold cointegration analysis

Given the consistent MTAR model is the best among these from the threshold
cointegration analyses, the error correction terms are constructed using Eqs.
(4) and (5b). The asymmetric error correction model with threshold cointegra-
tion is estimated and the results are reported in Table 4.

593
Item Zagreb Adriatic
Estimate t-value Estimate t-value
(Intercept) -0.205 -0.88 0.593* 1.779
0.062 0.332 -0.58* * -2.171

-0.033 -0.166 0.764* * * 2.909

0.079 0.429 0.144 0.545

0.255. 1.538 -0.373. -1.563

-0.126 -0.643 0.519* 1.845

0.369* 1.785 -0.166 -0.56

-0.297. -1.482 -0.136 -0.475

-0.138 -0.73 0.626* * 2.316

0.096 0.881 0.32* * 2.056

-0.018 -0.163 0.161 1

0.042 0.388 -0.386* * -2.507

-0.129 -1.275 0.172 1.189

-0.012 -0.093 0.212 1.12

0.135 0.909 -0.194 -0.916

-0.155 -1.003 0.279 1.261

0.242* 1.758 -0.05 -0.256

-0.028 -0.987 -0.051 -1.237

-0.039 -1.402 -0.164* * * -4.14

0.205 - 0.429 -

594
 Item Zagreb Adriatic
Estimate t-value Estimate t-value
AIC 316.449 - 398.333 -
BIC 371.173 - 453.057 -
0.924 - 0.705 -
QLB test(4)

0.417 - 0.261 -
QLB test(8)

1.213 [0.3] 2.988* * * [0]

0.92 [0.5] 2.773* * * [0.01]

1.475 [0.23] 3.895* [0.05]

3.283* [0.07] 0.577 [0.45]

0.791 [0.38] 0.97 [0.33]

0.477 [0.49] 0.002 [0.96]

=
0.08 [0.78] 4.733* * [0.03]

Table 4. Results of the asymmetric error correction model with threshold cointegration
Notes: Numbers in brackets are p-values. See Table 3 for QLB. For the hypotheses, H01
and H02 are Granger causality tests, H03 and H04 evaluate distributed lag asymmetric
effect, H05 and H06 assess the cumulative asymmetric effect, and H07 is about equilib-
rium adjustment path asymmetric effect.
* Denotes significance at the 10% level.
** Denotes significance at the 5% level.
*** Denotes significance at the 1% level.

Diagnostic analyses on the residuals with AIC, BIC and Ljung–Box Q statistics
select a lag of four for the model. In the equation for Zagreb, there are two coef-
ficients significant at the 5% level (i.e., ) and two coefficients significant
at the 10% (i.e., ). In equation for Adriatic, there are ninth significant
coefficients at least 5% (i.e. ). There are
two additional coefficients significant at the 15% level in each of the equations.
The R2 statistic is 0.205 for Zagreb and 0.429 for Adriatic. The AIC statistic is
316.45 for Zagreb and 398.333 for Adriatic. Overall, the model specification has
a better fit on Zagreb than on Adriatic. The hypotheses of Granger causality
between the prices are assessed with F-tests. The F-statistic of 2.988 and the

595
p-value of 0.000 reveal that the price of Zagreb does Granger cause the price
of Adriatic. However, the F-statistic of 1.213 indicates that the price of Adriatic
does not Grange cause the price of Zagreb. Similarly, the F-statistics of 2.773
for Adriatic disclose that the lagged price series have significant impacts on its
own price. Thus, in the short term, the price of Zagreb has been evolving more
independently while the price of Adriatic has been dependent on the price of
Zagreb in the previous periods and its own price.
Several types of hypotheses are examined for asymmetric price transmission.
The first one is the distributed lag asymmetric effect. In each price equation, the
equality of the corresponding positive and negative coefficients for each of the
four lags is tested; in total, there are eight F-tests for this hypothesis. It turns
out that two of them are significant at the 5% level. Distributed lag asymmetric
effect is found for Zagreb for Adriatic price at lag four and for Adriatic for Zagreb
price at lag one.
Furthermore, the cumulative asymmetric effects are also examined. The larg-
est F-statistic is 0.97 but none of the four statistics are significant at the conven-
tional level. Thus, there have been some distributed lag asymmetric effect but
cumulative effects are symmetric.
The final type of asymmetry examined is the momentum equilibrium adjustment
path asymmetries. For Zagreb, the F-statistic is insignificant. In contrast, for
Adriatic, the F-statistic is 4.733 with a p-value of 0.03. Thus, there is momen-
tum equilibrium adjustment asymmetry. The point estimates of the coefficients
for the error correction terms are −0.051 for positive error correction term and
- 0.164 for the negative one. While the sign is wrong for the first term, only sec-
ond of them are significant at the conventional level (the corresponding p-value
for -0.164 is 0.000). The magnitude suggests that in the short term the price of
Adriatic responds to the positive deviations by 5.1% in a month but by 16.4% to
negative deviations. Measured in response time, positive deviations take about
19 months to be fully digested while negative deviations take six months only.
Therefore, it seems that in the short term the price of Adriatic has some differ-
ent responding speed to positive and negative deviations. Namely, the price
of Adriatic has a much slower reaction to positive deviations from long-term
equilibrium than negative deviations.

5. Discussion of results
This section of the paper open discussion about price transmission mechanism
in the real estate business between two main markets within the Croatia found-
ed on our empirical results. The main aim of this paper was to study whether
the Adriatic region is a price leader in transmitting shocks on Zagreb real estate
market. We assumed that one of these regions has been the real estate price
leader of the market and its price has been evolving more independently.

596
Recent empirical literature did not provide great help. So far, unknown is if
any study that dealing with our hypothesis or same data processed with simi-
lar statistical technique, exist. Outlining similarities with other authors’ models
to compare our results in regard to economic significance with them is quite
impossible. In the general panorama of past-to-present literature about real
estate prices in Croatia and asymmetry transmission, early on, we did not find
similar research. Thus, using the opinions and results of others, in an econom-
ic sense, to justify the efforts of this research are absent from the discussion.
The linear cointegrating relationship between two real estate markets has been
used to pinpoint price leadership rule to one of them, by principle of exclude one
in this set of two. Zagreb bears the reputation of the price leader because the
statistic from the unit root test in Engle-Granger cointegration test is assessed
with better significant value (at 5% and not at 10%). In our case, Zagreb’s real
estate prices as the driving force was found to have a long-run equilibrium
relationship with the Adriatic real estate prices. This empirical result doesn’t
fit into the stylized story of real estate buyers travelling from abroad (and not
only they) to buy condominium and therefore affecting demand conditions in
neighboring’s region. Zagreb has been the price leader of the market and its
price has been evolving more independently. That result is not consistent with
the trade pattern in real estate business of the two regions over the study peri-
od. Adriatic region on average outperformed Zagreb in traded construction unit
volume and real estate prices as well. The price of Zagreb has been fluctuated
between 88.3 and 117 according to CREPI, which is lower than the price of
Adriatic (ranging from 100 to 137).
The transmission between the prices of Zagreb and Adriatic has been asym-
metric in both the long term and short term. The threshold cointegration analysis
(CMTAR) reveals that in the long term positive deviations of the price spread
between the two regions take about 500 months to be fully digested, while neg-
ative deviations take less than one month. Similarly, in the short term, the error
correction model reveals that Adriatic real estate buyers need 19 months to ful-
ly digest positive price shocks but about six months only for negative shocks.
Therefore, it seems that in the short term the price of Adriatic has some different
responding speed to positive and negative deviations. Namely, the price of Adri-
atic has a much slower reaction to positive deviations from long-term equilibri-
um than negative deviations. Overall, these firms, that where dealing with real
estate (developers, real estate agency, individual investors, home owners) are
more sensitive and act more promptly (with price menu correction), when price
fluctuations reduce their excepted profits. The prices where easily pushed up
with such a transmission mechanism and it helps to explain parallel price down-
turn after bursting the bubble. The coexistence of bubble ended while it burst
first in Zagreb (around starting of 2007) and Adriatic (in last quarter of 2009).

597
There are some interesting findings revealed in Granger causality relationships
that need to be discussed regardless hidden paradox in reveled prices direc-
tion. Firstly, although prices in Adriatic cities and other coastal sites may have
influences on some of the same region along the Croatia’s long coast, prices in
capital Zagreb region, lead to house price changes in the Adriatic. The finding
refutes the assumption that past house price movements in Adriatic may pre-
dict current Zagreb housing markets.
Furthermore, from the point of view of asymmetric price transmission in real
estate business, our results suggest that at least some of the claims of the
presence of nonlinearities in price transmission and associated price dynamics
direction raised in the existing literature should be re-visited in a multiregion-
al framework to account for the complexity of inter-country price interactions,
especially in those country where tourism sector plays important role and is
concentrated in some geographically homogenous region. Our paper aims to
contribute to the literature on the issue of interregional (within unique country)
price transmission, threshold behavior and asymmetric adjustments in the real
estate market.

6. Conclusions
Thriving construction business in before financial crisis was stimulated by hous-
ing credit, for credit achieves many goals at same time. It pushes up house
prices, making households feel wealthier. It creates more profits and jobs in the
financial sector as well as in real estate brokerage and housing construction. In
this paper we were focused on price dynamics prior and after financial crises
in Croatia. We formed hypothesis that swelling demand for dwelling, stimulated
by thriving tourism industry gives priority to Adriatic as price leader whereas
accession of Croatia to the European Union that gives advantage to capital city
plays not so important rule in getting former title. Several conclusions can be
drawn from the analyses that can be presented as a new contribution. Findings
confirm the asymmetric price transmission and threshold behavior in the real
estate market in these regions but refute our hypothesis that Adriatic region as
a strong tourist destination that attracts substantial buyers of the house units is
a price leader. Zagreb has been the price leader of the market and its price has
been evolving more independently. This is revealed by the resulted Granger
causality test, uni-directional price causality exists where Zagreb’s price cause
Adriatic’s price and not in vice versa. The research limitations emerged from
short time span, but our whish was to catch-up just this time-snapshot with
price time series in and around economic recession. Free fall of real estate
prices in Zagreb in a larger part of the observed period caused a price to de-
cline on the Adriatic coastal-side region. Adriatic price deflation was also in a
while stimulated to decrease by its own force. It certainly favors a relatively fast
convergence when negative deviation around the short and long-term equilib-
rium, of the prices occurred. Zagreb, comes to focus as a truly price leader, is

598
a capital city where housing prices have to begin fallen dramatically even two
years earlier than in Adriatic as an overture in construction recession. Despite
its vibrant economy otherwise, it is a city where it is relatively hard to build
new dwellings (hence, it mirrors heaviness of prices decline), but where syn-
ergies and spillovers abound, especially on Adriatic real estate price aspect.
The economic policy should mitigate intensity of negative asymmetric price
transmission effect to spillover along Adriatic. The action plan should encour-
age investors to build more houses and offices in other continental part of Cro-
atia, not exclusively in Adriatic, promoting other business by easing regulatory
barriers to make new business and building, from zoning rules to legal acts,
stimulating along this young population to stay in Croatia, in land with greater
possibility than now. Because, when the price of housing rises in that part of
Croatia, and the wealthy, who are more likely to own this kind of prime real es-
tate now or new generations, will get wealthier, asymmetric transmission effect
from Zagreb to Adriatic prices will become less stressful.

599
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Appendices

Figure A1. Monthly real estate price and mean in Zagreb

Note: First vertical line from the left shows mean value
Source: Author’s computation

Figure A2. Monthly real estate price and mean in Adriatic

Note: First vertical line from the left shows mean value
Source: Author’s computation

603
 CHAPTER 34

EU Benchmark Regulation after LIBOR manipulation

Sanja Gongeta1

ABSTRACT

This paper examines legal and economic implications of manipulation of reference in-
terest rate. In June 2012, the manipulation of the most significant reference interest
rate - LIBOR in which participated some of the largest banks was confirmed. This, as
many call it the biggest banking scandal undermined the confidence in the financial
markets and investor protection, but also pointed to the lack of legal regulation of such
fraudulent activities in the market. The main aim of this paper is to assess if the strength-
ening of the legal regulation can prevent possible further manipulation. The European
Parliament’s proposal for imposing penalties for trading based on inside information
and market manipulation is analyzed. The findings suggest the importance of adequate
regulatory framework, not only in the national but also in the broader context. Therefore,
the paper compares financial regulation in the United States and the United Kingdom
and analyses the latest Regulation for Benchmark – Setting in the European Union after
the LIBOR Scandal.

Key words: LIBOR manipulation, interest rates, benchmark setting,

Dodd Frank Act

JEL classification: G1, K2

1. Introduction
The London Interbank Offered Rate (“LIBOR”) is the benchmark reference rate2,
established in 1986, most commonly used in international finance markets to
interest rates paid between market counterparties and end users. (Walker,
2012:352) As an average interest rate for interbank loans, LIBOR represents
the end product of a calculation based upon submissions of lending rates by
leading banks. (Bainbridge, 2013.; Weldon, 2013: 202; Konchar, 2014)
Libor rates are produced daily for five major currencies: Pound Sterling (GBP),
European euro (EUR), Japanese yen (JPY), Swiss Franc (CHF), and US

1 Ph.D., senior lecturer, College of Applied Sciences Lavoslav Ružička in Vukovar, Županijska 50,
32000 Vukovar, Scientific affiliation: company law, commercial law. E-mail: sanja.gongeta@gmail.
com
2 A benchmark is an index or indicator calculated from a representative set of data or information
that is used to price a financial instrument or financial contract, or to measure the performance of
an investment fund.

605
Dollar (USD), with seven maturities quoted for each – ranging from overnight to
12 months, producing 35 rates each business day.
Latest data show that approximately $500 to $800 trillion worth of global finan-
cial instruments, including corporate debt, mortgages, student loans, interest
rate swaps, and other derivatives, are tied to LIBOR, so there’s no wonder that
LIBOR is often called the “world’s most important number”. (Braml, 2016; Yeoh,
2016; Kohn, 2014:456; Snider & Youle, 2012; Bainbridge, 2013; Yeung, 2013;
Konchar, 2014)
In August 2007, the LIBOR began to diverge from some of its historic relation-
ships (Snider & Youle, 2012) that caused some doubts in its proper functioning
and suspicion on manipulation by panel banks. The conduct of a number of
banks involved in setting the rates between 2005 and 2008 was investigated
by authorities in the United Kingdom, United States and elsewhere. (Walker,
2012:352) Investigations by regulators culminated in July of 2012 with ad-
missions of manipulation by Barclay’s, UBS, and the Royal Bank of Scotland.
UBS admitted to manipulating the Yen LIBOR, while Barclay’s has admitted to
manipulating the Dollar LIBOR.3Admissions of manipulating LIBOR on a wide-
spread and routine basis over the years have shocked both the regulators and
market participants alike.3 (Tabb & Groundfest, 2013)
In order to prevent market abuse, the LIBOR-setting process has been the
subject of considerable examination in many jurisdictions. It was clear that
adequate regulatory framework and improved structure and professionalism
embedded in the rate-setting process, is needed, not only for prevention, but
also for sanctioning such misconducts in financial world. (LIBOR Code of
Conduct, 2014)
Significant changes in, at that time existing regulatory frameworks, started
when Martin Wheatley4 conducted an investigation of possible reforms in LI-
BOR calculating method. (Weldon, 2013) The Wheatley Review of LIBOR in
September 2012 set out a plan for the reform of LIBOR which included reg-
ulation of LIBOR, institutional reform, the rules governing LIBOR, immediate
improvements to LIBOR and International co-ordination. (Wheatley Review,
2012) One of the reforms in Wheatley’s ten-point plan included transferring
responsibility for LIBOR administration from the British Bankers’ Association
(“BBA”) to a new administrator.5
The European Parliament also has adopted new rules to trading based on in-
side information and market manipulation and unlawful disclosure of informa-
tion defined as a serious offense and as such prescribes imprisonment for a
minimum term of four years. This is the first time across the European Union to
3 In the newspapers the scandal has been referred to as “epic in scale“, and „presumably the
biggest financial scandal ever“.
4 At the time LIBOR Scandal came to light Mr. Martin Wheatley was Managing Director of the
Financial Services Authority (FSA) and CEO-designate of the Financial Conduct Authority (FCA),
and is now CEO of the FCA.
5 The new administrator took over the LIBOR administration in February 2014.

606
impose penalties for market abuse, all in order to restore confidence of citizens
in the financial markets.
In addition, the aim of this article is to point out the importance of strengthening
legal regulation in order to prevent possible further manipulation. Therefore,
available data and scientific literature are analysed and compared.
The conclusion of this article is that adequate regulatory framework is crucial
for preventing manipulations in benchmarks settings which affects the health of
financial markets and eventually financial stability.
This article is organized as follows. Section 2 summarizes the extant literature
of history and significance of LIBOR, definition of manipulation, with special
emphasis on LIBOR manipulation, Section 3 presents the methodology ana-
lysing the latest reforms in benchmark Regulations, and Section 4 the data.
Section 5 presents and discusses the results and avenues for further research,
while Section 6 concludes the paper.

2. Literature review
There is a wide literature on one of the most popular interest–rate models. This
article relates to two main streams of the literature – the one that defines and
explains the importance of Libor, and the recent one that studies on Libor ma-
nipulation and its consequences.
As noted before, the London Interbank Offered Rate is a set of indices that
represent the prevailing interest rates in London money markets denominated
in various currencies and for various durations and represents the cost of funds
for major banks lending to each other. (Brady, 2012:2)
Similar rates exist in other markets, like the Hibor in Hong Kong, but some
previously existing rates like Pibor in Paris, the Fibor in Frankfurt and the Ribor
in Rome, merged into the EURIBOR (Euro Interbank Offer Rate), which is the
benchmark interbank rate offered in the Euro zone for unsecured funds in Euro.
(van Gestel & Baestens, 2009)
The LIBOR Market Model was introduced by Miltersen, Sandmann and Son-
dermann (1997) and Brace, Gatarek and Musiela (1997). As Goetsch (2006:13)
clarifies, the model is called BGM from the names of the authors of one of the
first papers where it was introduced.
Rebonato (2002) reviews a historical development of LIBOR market model,
lays out its mathematical and modelling framework and shows the types of
product that can be handled by the modern pricing approach.
With their numerical illustrations Gaterek, Bachert and Maksymiuk (2006) pro-
vide the starting point to master market model skills. Theoretical and practical
issues of the LIBOR market model are presented in Goetsch (2006).

607
Regulatory investigations connected to the LIBOR scandal are on-going story
and, in accordance to that, the story is interesting for many researchers.
The first doubts in LIBOR manipulation where presented in different newspa-
pers6 written by columnists of market practitioners at the beginning of 2008 fol-
lowed by the first papers written and published within academia. (Kohn, 2014;
Fouquau and Spiser, 2015:634; Yu, 2013)
In 2008 Abrantes-Metz et al. extended the Wall Street Journal Study and com-
pared of LIBOR with other rates of short-term borrowing costs, evaluated the
individual bank quotes submitted to the British Banker’s Association and made
a comparison of these individual quotes to individual CDS spreads and market
cap data.7 (Fouquau & Spieser, 2015:634)
Christopher Hall presents the three issues in his research: a problem with the
people involved in setting LIBOR, a problem with the publicity that banks face
when they submit their rates to LIBOR and a problem with the way LIBOR is
calculated that allows it to diverge too far from market realities. Hall also com-
pares Banking Regulations in the United Kingdom and in the United States and
explains how the Wheatley Review “embodies the hybrid approach” of these
two systems.
Allen Kohn defines LIBOR and answers the question “what went wrong” by
explaining early warnings signs and responses to LIBOR being manipulated.
Abrantes-Metz, Rauterberg and Verstein (2013) bring relevant review of ma-
nipulation in the United States after the Dodd-Frank Act. For resolving a lack
of trust in rate setting process, Rebecca Tabb and Joseph Grundfest (2013)
research adequate substitutes and alternatives for LIBOR.

3. Methodology/Method/Model/Conception of analysis
Money market, where banks lend each other cash or borrow it from the central
bank, is one particularly important market in the financial world. Banks always
negotiate individually over the rate at which they enter into a loan and that rate
changes arbitrarily over time, there is the concept of an average rate which is
fixed once on a daily basis. (Kenyon & Stamm, 2012:1)
In the EUR market, that Interbank Offer Rate is called EURIBOR and for all
currencies that are traded on the money market in London is called LIBOR.
(Kenyon & Stamm, 2012:2)

6 Mackenzie and Tett, as well as Mollenkamp and Whitehouse in 2008 questioned the honesty of
LIBOR in different newspapers (The Wall Street Journal, Global Financial Stability Review, Finan-
cial Times) in an attempt to estimate heuristically the normal level of LIBOR from an intuitive point
of view.
7 The authors made their research with different analyses during the three periods crucial for
LIBOR manipulating suspicions. Period 1 included: 1/1/07 through 8/8/07, Period 2: 8/9/07 through
4/16/08, and Period 3: 4/17/08 through 5/30/08.

608
As earlier said, the object of this article is to point out the importance of ade-
quate legal regulation in preventing possible further manipulation in benchmark
setting, so the emphasis on the recent literature of LIBOR manipulation and its
economic and legal impact is taken.
The methodology used in this article is consistent with those that are usually
used to point out the potential anticompetitive behaviour by market participants.
Following the Yeoh (2016), Hall (2013), Kohn (2014) and Abrantes-Metz, Rau-
terberg and Verstein (2013) research, this article makes an overview from the
history of LIBOR and its significance to the research of LIBOR manipulation
and latest legal reforms.
Also, like Abrantes-Metz, Rauterberg and Verstein’s research from 2013, this
article analyses the definitions and common types of manipulation, regarding
on LIBOR manipulation.
In order to prove the importance of adequate regulatory framework, not only in
national legislation, but also in wider context, the European Parliament’s regu-
lation for imposing penalties for trading based on inside information and market
manipulation is analysed.

4. Empirical data (documentation background) and analysis

In addition to explain the importance of stronger and adequate regulatory
framework, not only in the national but also in the broader context, this section
contains the theoretical analyses of recent researches.

4.1. History and Significance of LIBOR

Back in the 1969 the London branch of Manufacturers Hanover Bank organized
an $80 million syndicated loan for the Shah of Iran pegged to an interbank of-
fered interest rate based in London. According to Yu (2013:1277) that’s the one
of the first uses of LIBOR. In his article, Yu also explains that “the boom of the
global loan market and the creation of the Eurodollar paved the way for Libor’s
broad use as a benchmark rate based in London”.
In the mid-1980’s the British Banker’s Association sought to standardize rate
terms on interest rate swaps between London based banks and in 1986 intro-
duced London Interbank Offered Rate (LIBOR) to standardize rate terms on a
wider variety of securities, including syndicated loans, futures contracts, and
forward rate agreements. (Abrantes-Metz et al. 2008:4; Hou, Skeie, 2014:1)
At that time LIBOR fixings were calculated for the U.S.dollar, the British pound,
and the Japanese yen.
In modern markets LIBOR serves two primary purposes: as a reference
rate - a rate that financial instruments can contract upon to establish the terms
of agreement and as benchmark rate, which reflects a relative performance

609
measure, often times for investment returns or funding costs. LIBOR serves
as the primary reference rate for short-term floating rate financial contracts like
swaps and futures. (Hou, Skeie, 2014:1)
In their research Hou and Skeie “LIBOR: Origins, Economics, Crisis, Scandal,
and Reform” seek for the rationale for the wide usage of LIBOR. They conclude
it stems from its construction “Because LIBOR represents the terms at which
the world’s largest and most financially sound institutions are able to obtain
funding on a short-term basis, it serves as the lower bound for the borrowing
rate of other less creditworthy institutions and individuals”. (2014:3)
From its beginning until the early 2014,8 LIBOR was administrated by British
Banker’s Association (BBA) which main role included lobbying efforts on the
behalf of more than 200 banks from nearly 60 countries doing business in the
United Kingdom, and promoting the banking industry reputation. (Konchar,
2014:3)
From the 1st February 2014, the new administrator, ICE Benchmark Administra-
tion (IBA) took over the responsibility on administrating LIBOR. From that date
“the world’s most important number”, formerly known as BBA LIBOR became
ICE LIBOR.
(ICE) LIBOR is designed to reflect the short term funding costs of major banks
active in London. (Yu, 2013) Like other financial benchmarks, LIBOR is a
“polled” rate which means that a panel of representative banks submits rates
which are then combined to give the LIBOR rate. LIBOR is a benchmark rate
produced for five currencies with seven maturities quoted for each - ranging
from overnight to 12 months, producing 35 rates each business day.9
As earlier said, ICE Benchmark Administration maintains a reference panel of
contributor banks for each currency calculated. IBA currently fixes in the fol-
lowing five currencies: CHF (Swiss Franc), EUR (Euro), GBP (Pound Sterling),
JPY (Japanese Yen) and USD (US Dollar).
Panel banks are required to submit a rate in answer to the LIBOR question: “At
what rate could you borrow funds, were you to do so by asking for and then
accepting inter-bank offers in a reasonable market size just prior to 11 am Lon-
don time?” Submissions are based upon the lowest perceived rate at which a
bank could go into the London interbank money market and obtain funding in
reasonable market size, for a given maturity and currency.10

8 In section three, Reform in Banking Regulation we’ll explain why did a new administrator take
over LIBOR.
9 https://www.theice.com/iba/libor (October 3, 2017)
10 https://www.theice.com/iba/libor (October 3, 2017)

610
 NUMBER OF
NUMBER OF
METHODOLOGY CONTRIBUTOR RATES
CONTRIBUTORS
AVERAGED
Top 4 highest rates,
16 8
tail 4 lowest rates
Top 4 highest rates,
15 7
tail 4 lowest rates
Top 3 highest rates,
14 8
tail 3 lowest rates
Top 3 highest rates,
13 7
tail 3 lowest rates
12 Top 3 highest rates,
6
tail 3 lowest rates
Top 3 highest rates,
11 5
tail 3 lowest rates

Table 1. Calculating LIBOR

Source: https://www.theice.com/iba/libor

As explained in Table 1, every ICE LIBOR rate is calculated using a trimmed

arithmetic mean.11 Once each submission is received, they are ranked in de-
scending order and then the highest and lowest 25% of submissions are ex-
cluded. This trimming of the top and bottom quartiles allows for the exclusion of
outliers from the final calculation.
The remaining contributions are then arithmetically averaged and the result is
rounded to five decimal places to create an ICE LIBOR rate. This is repeated
for every currency and maturity, producing 35 rates every business day

4.2. Manipulation of LIBOR

In 2007 Libor appeared artificially low, signalling that banks might be understat-
ing borrowing costs to hide their financial problems. (Konchar, 2014:5; Mollen-
kamp, Whitehouse, 2008) and during the sub-prime mortgage crisis of 2008,
there was worry about the health of individual banks and their ability to with-
stand the crisis. (Hall, 2014:160)
The first doubts in LIBOR manipulation where presented in different newspa-
pers12 written by columnists of market practitioners at the beginning of 2008 fol-
lowed by the first papers written and published within academia. (Kohn, 2014;
Fouquau and Spiser, 2015:634; Yu, 2013)
11 The methodology is reviewed by the ICE LIBOR Oversight Committee as documented in its
Terms of Reference. The frequency of reviews is set by the Oversight Committee through its Cal-
endar of Agenda Items.
12 Mackenzie and Tett, as well as Mollenkamp and Whitehouse in 2008 questioned the honesty of
LIBOR in different newspapers (The Wall Street Journal, Global Financial Stability Review, Finan-
cial Times) in an attempt to estimate heuristically the normal level of LIBOR from an intuitive point
of view.

611
The Wall Street Journal’s analysis indicated “that several banks—Citigroup, JP
Morgan Chase, and UBS—were reporting significantly lower borrowing costs
for the Libor than other market measures suggested”…. and knowing that “Li-
bor is supposed to reflect the average rate at which banks lend to each other,
the effect was that it appeared that the banking system was doing better than it
actually was”. (Konchar, 2014:7; Mollenkamp, Whitehouse, 2008)
In the meantime, facts regarding LIBOR manipulation were coming to light
showing that both internal and external manipulation requests were numerous
and made verbally and in writing.
In late June 2012 the United Kingdom’s Financial Services Authority and Bar-
clays Bank PLS announced a settlement agreement in which Barclays agreed
to pay a fine of $92.8 million U.S. dollars and acknowledged its role in manip-
ulating the LIBOR.
Hall (2014:158) explains “Financial Services Authority found that “Barclay’s act-
ed inappropriately on numerous occasions between January 2005 and July
2008 by making US dollar submissions . . . that took into account requests
made by its (own) interest rate derivatives traders.” Barclays’s LIBOR sub-
missions also considered requests from derivatives traders from other banks.
Furthermore, the Financial Services Authority found that Barclay’s had manip-
ulated LIBOR submissions by “taking into account concerns over the negative
media perception of Barclays’s LIBOR submissions.” LIBOR submissions are
supposed to be formed only as a response to the prompt question. Consid-
eration of either of these factors was therefore inappropriate because neither
factor was directly related to the cost of borrowing money. The CFTC’s charges
and findings in the United States echoed those of the FSA”.”
As noted before, Barclay’s manipulation requests where both internal and ex-
ternal. External manipulations of LIBOR were at the request of traders13, and
internal requests of LIBOR manipulations were of Barclay’s Management.

13 As Hall (2014:159) notices, E-mail correspondence was informal: “Your annoying colleague
again . . . Would love to get a high 1m Also if poss a low 3m . . . if poss . . . thanks” (February 3, 2006,
Trader in London to Submitter). “Hi Guys, We got a big position in 3m libor for the next 3 days. Can
we please keep the libor fixing at 5.39 for the next few days. It would really help. We do not want to
fix any higher than that. Tks a lot.” (13 September, 2006; Senior Trader in New York to Submitter).

612
After Barclay’s settlement, in early 2013, similar settlements were announced
with both the Royal Bank of Scotland and UBS. (Hall, 2014:154,155)14 The cu-
mulative fines for LIBOR manipulation reaching amount to $8 billion dollars is
larger than any of the previous fines imposed on financial institutions.
Regulatory investigations connected to the LIBOR scandal are on-going story
and, in accordance to that, the story is still interesting for many researchers.

4.3. Reforms in Banking Regulation

As noted before, the LIBOR scandal undermined the confidence in the financial
markets and investor protection, but also pointed to the lack of legal regulation
of such fraudulent activities in the market.
Gandhi et al. (2015:1) and Coffee (2007) notice that LIBOR manipulation ap-
peared in banks incorporated outside the United States, where enforcement
was “historically weaker”. 15
As Hall (2015:170) concludes, it is because banking regulation in the United
States “represents a set of accumulated responses to a long history of finan-
cial crises, scandals, happenstance, personalities, and compromises among a
broad and competing array of industry and government units.”16
The main financial regulator in the United Kingdom is the Financial Services
Authority, created by the Parliament after passing the Financial Services and
Markets Act of 2000 (FSMA). With its operationally independence from the gov-
ernment of the United Kingdom, the Financial Services Authority measures fi-
nancial firms according to guiding principles17: “maintain confidence in the U.K.
financial system, contributing to the protection and enhancement of the stability
of the U.K. financial system, securing the appropriate degree of protection for

14 At last, UBS fessed up first and cooperated with a DOJ investigation in order to avoid criminal
charges in connection with currency rigging. Total fines: $545 million $203 million criminal fine to
the DOJ in connection to LIBOR rate rigging; $342 to the Federal Reserve in connection with its
forex investigation (no criminal charges); Barclays: Total fines: $2.4 billion, Eight additional employ-
ees fired for their roles in forex manipulation; Fine breakdown: $650 million criminal fine to the DOJ,
plus an additional $60 million fine for violating a non-prosecution agreement. So $710 million to
the DOJ total; $342 million to the Federal Reserve in connection with its forex investigation; £284
million (about $443 million) to the UK’s Financial Conduct Authority $485 million to the New York
State Department of Financial Services; $400 million to the CFTC;
Citi: Fines: $925 million criminal fine to the DOJ; $342 million to the Federal Reserve in connection
with its forex investigation; JPMorgan Fines: $550 million criminal fine to the DOJ; $342 million to
the Federal Reserve in connection with its forex investigation; Royal Bank of Scotland :Fines:$395
million criminal fine to the DOJ; $274 million to the Federal Reserve in connection with its forex
investigation; Bank of America: Fines: $205 million civil monetary penalty to the Federal Reserve;
Deutsche Bank $2.5 billion, Societe Generale $605 million.
15 In order to explain the US tradition of securing the free financial market, it is important to point
out The Sherman Antitrust Act, enacted in 1890, as the leading federal statute on competition law
that is designed to deter activities that reduce competition in the marketplace.
16 Hall also brings a detailed description of federal regulatory agencies relevant to the LIBOR
scandal: The Commodities Futures Trading Commission and The Department of Justice.
17 These “Principles of Businesses” Barclay’s violated in the LIBOR scandal.

613
consumers and reducing the extent to which it is possible for a business carried
on. To be used for a purpose connected with financial crime.” (Hall (2015:163)
After the LIBOR manipulation became public, the Chancellor of the Excheq-
uer requested a review and report on the reforms to LIBOR. This review, later
named Wheatley’s review, after Martin Wheatley, identified several key weak-
nesses in then-current U.K. regulatory model as it related to LIBOR and the
final report made a number of recommendations to address the problems iden-
tified with LIBOR. (Hall, 2015:166)
The recommendations included “introducing statutory regulation of administra-
tion of, and submission to, LIBOR and “the creation of new criminal offenses
under the FSMA”. (The Wheatley Report, 2012)
After regulators launched formal investigations and soon after the first allega-
tion of LIBOR manipulation, the first change (following Wheatley Report recom-
mendations) was made in 2013 when the administration of LIBOR was trans-
ferred from British Banking Association to the ICE Benchmark Administration.
Comparing the United States and the United Kingdom banking regulation in
light of the LIBOR scandal, it is evident that adoption of the Review’s recom-
mendations represents a move towards the U.S. model which includes more
invasive regulation and sanctions. Hall (2015:180) concludes that the United
Kingdom move forward to the better model of financial regulation, especially
enacting the recommendations of the Review.
LIBOR manipulation scandal also made its effect on European Union’s legal
framework.
At the European Union level, in July 2012 the European Commission put for-
ward proposal to amend its proposals for a Regulation on market abuse and
for a Directive on criminal sanctions for market abuse to ensure that any ma-
nipulation of benchmarks is clearly illegal. (ESMA-ESBA Principles on Bench-
mark-Setting Process in the EU:6)
On 6 June 2013 European Securities and Markets Authority (ESMA) and Eu-
ropean Banking Authority (EBA) published Principles on Benchmark-Setting
Process in the EU to address the problems in the area of benchmarks as a
transition path toward potential future legal obligations. The Principles didn’t
replace any EU or national regulation in that area but were crucial for the pe-
riod until a formal regulatory and supervisory framework for benchmarks has
been devised. In order to instil confidence in financial markets and market par-
ticipants as well as guarantee the integrity of the Benchmark formation pro-
cess, a framework for any Benchmark setting process was obliged to include
that Principles.
The Principles covered every stage of the Benchmark process starting with
Benchmark Data Submission, Benchmark Administration, Benchmark Cal-
culation, Benchmark Publication the use of Benchmarks, and the continuity
of Benchmarks.

614
On September 2013, the European Commission published Proposal for a Reg-
ulation on indices used as benchmarks in financial instruments and financial
contracts explaining some crucial changes that should be made.
The main objective of the Proposal was to ensure that benchmarks produced
and used in EU are robust, reliable, and representative and fit for purpose and
that they are no longer subject to manipulation. (MEMO:3)
Proposal suggested crucial changes that included: regulation and supervision
of benchmark providers and contributors who already were regulated (financial
institutions); Managing conflicts of interest; ensuring appropriate governance
and controls over the benchmark-setting process made by the providers of
benchmarks and contributors to benchmarks; transparent and robust method-
ologies that need to ensure the use of sufficient, accurate and representative
underlying data; improved transparency of the benchmark-setting process; and
suitability of assessments of benchmarks for retail contracts. (MEMO:3)
On 17 May 2016, the European Council adopted this new rules aimed at en-
suring greater accuracy and integrity of benchmarks in financial instruments.
It is important to note that before the latest Regulation on indices used as bench-
marks in financial instruments,18 Union consumer protection rules did not cover
the particular issue of adequate information on benchmarks in financial contracts.

5. Results and discussion

Manipulations are quite different from traditional price-fixing cartels so the dif-
ferent approaches to detect manipulation are needed. As Abrantes-Metz at al.
(2008:7) research explains, “Screening processes for manipulations are very
similar to those for conspiracies, but they are difficult to develop and implement
because of the variety of forms that are utilized by manipulators”.
LIBOR manipulation is being described as “a cartel of banks manipulating inter-
est rates that affect hundreds of trillions of dollars in financial products, includ-
ing adjustable rate mortgages, credit cards, interest rate swaps, and interest
rates on government bailout funds”. (Foster, 2015:292)
Knowing that LIBOR rates are a benchmark for interest rates on a global scale,
and knowing that LIBOR is an indicator of the financial stability of the major
banks in the world, it is clear that it has to be predictable, stable, and reflect
market fundamentals.
Following and analysing some recent papers on LIBOR scandal (Fouquau,
Spieser, 2015:633; Walker, 2012, Konchar, 2014, Abrantes-Metz at al. 2008,
Gotsch, 2006, Foster, 2015) this article shows that the integrity of benchmark

18 Regulation (EU) 2016/1011 of the European Parliament and of the Council of 8 June 2016 on
indices used as benchmarks in financial instruments and financial contracts or to measure the
performance of investment funds and amending Directives 2008/48/EC and 2014/17/EU and Reg-
ulation (EU) No 596/2014 OJL of the European Union, L 171.

615
reference rates is of fundamental importance to all financial markets, in that
LIBOR is supposed to be an overall and reliable assessment of the health of
the financial system. LIBOR manipulation was initially stronger for banks incor-
porated outside the United States “Where enforcement is historically weaker,
and that is disappeared in the aftermath of LIBOR investigations” (Gandhi et
Al, 2015)
The most complete study was made by Abrantes-Metz et al. (2011) who com-
pared many different analyses during period affected by different and signifi-
cant economic events (01.01.2007.-05.03.2008). They made a comparison of
LIBOR with other rates of short-term borrowing costs, an evaluation of individ-
ual bank quotes and a comparison of these individual quotes to individual CDS
spreads and market cap data. (Fouquau, Spieser, 2015:634)
Ghandi et al. (2015:4) found that the evidence for manipulation is initially strong
but disappears after 2010 and they connect it with the regulators investigation
of banks in their probe of LIBOR manipulation.
In order to prevent market abuse, The United Kingdom, as well as The Euro-
pean Parliament, have adopted new rules to trading based on inside informa-
tion and market manipulation and unlawful disclosure of information defined
as a serious offense and as such prescribes imprisonment for a minimum term
of four years.
The EU has taken a further step towards restoring public trust in financial bench-
marks in the wake of recent scandals over the manipulation of the LIBOR and
EURIBOR benchmarks. In a move welcomed by the European Commission,
the Council has given its backing to new proposed rules to enhance the ro-
bustness and reliability of benchmarks, which are used in financial instruments
(e.g. bonds, shares, futures or swaps) and financial contracts (e.g. mortgages
or consumer contracts) in the EU.
The Commission proposed new standards in September 2013 after it emerged
that some benchmarks had been manipulated, resulting in multi-million euro
fines on several banks in Europe and in the US, and these new rules were
adopted in 2016.

6. Conclusions
The LIBOR manipulation scandal is the last banking scandal brought to the
light since the financial crisis of 2008. The pricing of many financial instruments
and financial contracts depends on the accuracy and integrity of benchmarks
and the free financial market must be competitive and transparent. Knowing
that LIBOR rates are a benchmark for interest rates on a global scale, and
knowing that LIBOR is an indicator of the financial stability of the major banks
in the world, it is clear that it has to be predictable, stable, and reflect market
fundamentals.

616
After LIBOR manipulation became public, a number of initiatives to reform ref-
erence rate-setting mechanisms have been launched across wide parts of the
regulatory communities and the financial markets. In order to prevent market
abuse, the European Parliament adopted new regulation on indices used as
benchmarks in financial instruments and financial contracts. This is the first
time across the European Union to impose penalties for market abuse, all in
order to restore confidence of citizens in the financial markets.
The new regulation aims to enhance the robustness and reliability of bench-
marks, thereby strengthening confidence in financial markets but also aims to
restore trust in indices used as financial benchmarks, following manipulation
scandals in recent years.
Whether they succeeded, it remains to be seen in the upcoming time

617
REFERENCES
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Manipulaton Law: The New CFTC Rules and the Urgent Need for Eco-
nomic and Empirical Analyses, University of Pennsylvania Journal of
Business Law, 2013., Vol. 15, pp. 357-418

Abrantez-Metz, Rosa M et al. LIBOR Manipulation?, Working paper (2008)

Available at SSRN: http://ssrn.com/abstract1201389

Bainbridge, S.: Reforming LIBOR: Wheatley versus the alternatives; NYU

Journal of Law & Business, vol. 9, no. 2 (2013); 789-849

Foster, S. E., LIBOR Manipulation and Antitrust Allegations, DePaul Business &
Commercial Law Journal, Vol 11:291, 2015, 291 – 330

Fouquau, J., Spieser, P.K.: Statistical evidence about LIBOR manipulatin: A

“Sherlock Gatarek D., Bachert P., Maksymiuk, R.: (2006) The LIBOR
market model in practice, John Wiley&Sons, Ltd.

Gotsch, I. (2006) Libor Market Model; Theory and Implementation, VDM Verlag
Dr. Muller

Hackl, C. (2014), Calibration and Parameterization Methods for the Libor Mar-
ket Model, Springer

Hall, C., Anything for You Big Boy: a Comparativ Analysis of Banking Regula-
tion in the United States and the United Kingdom in Light of the LIBOR
Scandal, Northwestern Journal of International Law & Business, 34:153,
2013, 153-180

Holmes” Investigation, Journal of Banking & Finance, 50: 2015, 632 – 643

Hornuf, L., Haas, G.: Regulating Fraud in Financial Markets: Can Behavioral
Designs Prevent Future Criminal Offences? Journal of Risk Manage-
ment in Financial Organizations Vol. 7 Issue 2 (2014); 192-201.

Hou David, Skeie David: LIBOR: Origins, Economics, Crisis, Scandal and Re-
form; Federal Reserve Bank of New York Staff Reports, no. 667, March
2014.

Kenyon, C., Stam, R. (2012) Discounting, LIBOR, CVA and Funding, Interest
Rate and Credit Pricing,

Kohn, A., LIBOR: The Clearinghouse and exchange based solution, Fordham
Journal of Corporate & Financial Law, Vol XIX., 2014, 455 – 491

Konchar, S.: The 2012 Libor Scandal: An Analysis of the Lack of Institutional
Oversight and Incentives to Deter Manipulation of the World’s Most “Im-
portant Number”, 2014,

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Rebonato, R. (2002) Modern Pricing of Interest-Rate Derivatives; The LIBOR
Market Model and Beyond; Princeton University Press

Mollenkamp C, Whitehouse, M. (2008) Study Casts Doubt on Key Rate, WALL

ST. J. http://online.wsj.com/article/SB121200703762027135.html

Proposal for a Regulation on indices used as benchmarks in financial instru-

ments and financial contracts – Frequently Asked Questions available at:
http://europa.eu/rapid/press-release_MEMO-13-799_en.htm [Accessed:
January 10, 2018]

Snider, C., Youle, T.; The Fix is In: Detecting Portfolio Driven Manipulation of
the LIBOR (2012)

Snider, C., Youle T. (2012). “The Fix Is In: Detecting Portfolio Driven Manipula-
tion of the Libor,” University of Minnesota working paper.

Tabb, V., Grundfest, J.: Alternatives to LIBOR, Capital Markets Law Journal
(2013) 8 (3): 229-260

Van Gestel T., Baesens, B. (2008) Credit Risk Management, Basic Concepts:
financial risk components, rating analysis, models, economic and regu-
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Walker, G.A.: Reference Rate Regulation and LIBOR, Banking & Financial Re-
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Wall Street Journal The LIBOR Investigation. http://stream.wsj.com/story/

the-libor-investigation/SS-2-32262/https://www.theice.com/iba.jhtml [Ac-
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Weldon, J.: The Libor manipulation Scandal & the Wheatley Review: A Band-
Aid on a Knife Wound, Syracuse J. INt’L & Com, (2013) Vol. 41:1,
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Yeung, T.: From Libor to Hibor: The Implications of Libor Scandal on the Bank-
ing regulation and governance in Hong Kong in the exercise of Hibor
fixing, Working paper No. 12., Centre for Financial Regulation and Eco-
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Yu, Milson C.: Libor Integrity and Holistic Domestic Enforcement, Cornell Law
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619
 CHAPTER 35

Monetary and absorption approach to explain

croatian current account

Milan Bošnjak, Ivan Novak, Ante Krišto

ABSTRACT

The paper brings the determinants of Croatian current account dynamcs under mon-
etary and absorption approach. The research employed newly developed Non-linear
Autoregression Distributed Lag (NARDL) approach that takes into account nonlinear
and asymmetric nature of the relitationship between Croatian current account and its de-
terminants. Estimated results on a quartarly data sample from the first quarter of 2000 to
the second quarter of 2017 reveals that that Croatian current account can be expalined
using monteray and absorption approach. Domestic demand, real exchange rate index,
loans to private sector and monetary aggregates M4 are tested as the determinants of
Croatian current account. Monetary aggregates M4 are found to hold the highest ex-
planatory power among tested monetary variables.

Key words: asymmetric cointegration, current account, monetary approach,

absorbtion approach, Croatia.

JEL Classification: C22, C51, F14, F43.1

1. Introduction
Croatia experienced trade and financial liberalization in a last two and half de-
cades and eventually joined the European Uninon (EU). The current account
deficit in Croatia and other similar countries persisted until recently. One stand
of litarature expain the current account deficit of European transition countries
by growth in domestic demand financed by the inflow of foreign loans and real
appreciation of domestic currencies (Aristovnik, 2008; Zakharova, 2008; Bak-
ker and Gulde, 2010; Obadić et al., 2014). Bilas and Bošnjak (2015) examined
of international trade between Croatia and the rest of the EU member countries
and found that trade patter as suggested by Heckscher-Ohlin trade theorem
while Croatia appeared as the labour abundant country. This paper examines
the Croatian current account in lights of monetary and absorption approach. The
main idea of absorption approach is that current account will improve if its output
of goods and services increases by more than its absorption (Harberger, 1950).

* This paper is published in Proceedings of Rijeka Faculty of Economics-Journal of Economics

and Business/Zbornik Ekonomskog fakulteta u Rijeci: časopis za ekonomsku teoriju i praksu, Vol.
36, No.2, pp. 929-946, DOI: https://doi.org/https://doi.org/10.18045/zbefri.2018.2.929

621
The monetary approach pointed on demand and supply of money and its rela-
tionship as the one that determines current account balance (Polak, 1957). It is
reasonable to assume that the former as well as the later approach contributes
to explain the dynamics in the Croatian current account.
The remainder of this paper is organized as follows: Section 2 briefly summa-
rizes existing literature related to the topic under consideration. Section 3 pre-
sents methodology and research data, while Section 4 empirical analysis. The
final section provides an overview of the main findings of the research.

2. Brief related literature overview

Ozgur and Memis (2017) examined the trade deficits of the eleven eurozone -
countries and explained the tradede deficit of sample countries by credit expan-
sion and asset prices while no significant effects was reported for countries with
trade surpluses. Shahid Hassan et al (2017) employed ARDL bound testing to
examine the determinants of trade deficit in Pakistan, India and Bangladesh
and found real effective exchange rate, per capita income and money supply
as the significant determinant of trade flows for the considered countries. Da-
vis et al. (2016) pointed that combination of credit growth and external deficits
increases the probability of a banking crisis. Ekinci et al. (2015) suggest that
at the early stages of financial development, acceleration in the credit growth
might cause deterioration in the current account. Elhaddadi and Karim (2017)
examined the Moroccan case under monetary approach (Polak, 1957) and re-
ported the theoreticaly consistent adjustment. Khalid Yousif and Attahir Musa
(2017) employed VECM approach in its linear specification form to examine the
determinants of Sudan balance of payments and reported the significant role of
foreign debt, inflation, gross domestic product and exchange rate. Meniago and
Hinaunye Eita (2017) reported the significant role of exchange rate changes
for imports, exports and trade balance in Sub-Saharan Africa but the response
is found to be extremely low. Chukuet al.(2017) examined the long-run and
short-run determinants of current account balances in West Africa and reported
different short-run and long-run determinants. Unger(2017) pointed that bank
loans to the non-financial private sector were a significant determinant of the
current account in the countries with current account deficit. Folloeing the ex-
tensive overview of empirical literature Kauko (2014) pointed that during a typi-
cal build-up phase, domestic banks borrow internationally to finance domestic
lending and consequently boosting the current account deficit. Some recent
papers reported nonliner and regime dependent dynamics in trade flows (Kha-
daroo, 2016; Topalli and Dogan, 2016). Conclusively, this paper contributes to
the existing literature with Croatian case while taking into account the posible
nonlinear and asymmetric relationship between Croatian current account and
its determinants.

622
3. Research data and methodology
The research is based on the quartarly data on imports, exports, domestic de-
mand, real effective exchange rate index, loans to private sector and montetary
aggregates M4 from the first quarter of 2000 to the second quarter of 2017.
The imports, exports and domestic demand series are obtained from Croatian
Bureau of statistics while real effective exchange rate index, loans to private
sector and montetary aggregates M4 series are obtained from Croatian Nation-
al Bank. The observed series that represent current account in this paper is
given by the equation (1):

(1)

where IMP represents the level of import and EXP the level of exports.
Domestic demand over Gross Domestic product (GDP) is represented by the
variable Loans to private sector over GDP and montetary aggregates M4 over
GDP are represented by the variables LTPS and M4, respectivelly. Real effec-
tive exchange rate index is denoted by the variable REER All of the variables
under consideration are X-13 ARIMA seasonally adjusted and taken in (natural)
log values. Firstly, using standard unit root test (ADF, PP, KPSS) the variables
are tested for existence of unit root and insigts into property of stationarity are
provided for the observed series. Here needs to be stated that the Non-lin-
ear Autoregression Distributed Lag (NARDL) approach we follow in this paper
requires that all of the observed variables are stationary I(0) or integrated of
order one I(1). NARDL approach developed by Shin et al. (2011) is employed
in this paper in order to take into account the nonlinear relationship between
the Croatian current account and variables under consideration. In the NARD
approach we follow in this paper the short – run and long-run nonlinearities are
introduced through positive and negative partial sum decompositions of the
explanatory variables. As already stated and contrary to standard linear cointe-
gration approach, this model specification does not depend on the degree of
the integration of the variables.
So, the increase ( ) and decrease ( ) of of the independent variables ( )
can be defined with the application of partial sum process as given by the equa-
tions (2) and (3).

(2)

(3)

Firsly, NARDL model is employed to obtiane the estimates for the absorption
approach only and the model specification is given by the equation (4):

(4)

623
Similarily, the model specification is extended using various variables repre-
senting the monetary sector (real effective exchange rate index, loans to pri-
vate sector and montetary aggregates M4). After the NARD model estimates
are obtained, following Pesaran et al. (2001) the long run and short run asym-
metric effects are tested. Eventualy, using ARCH Test, Breusch-Godfrey Serial
Correlation LM Test and Jarque-Bera Test diagnostic test are performed for
each od the estimated model.

4. Empirical results and discussion

Following the procedure described in the section Research data and methodol-
ogy, unit root testsresults are summarized in Table 1.

Levels First difference

Variable
and test Constant Constant
Constant Constant
and trend and trend
ADF test t-stat.
-1.373234 -3.690647 -10.72338 -10.83391
-3.068337 0.006005 -2.933066 -5.304565
-1.542579 -3.499165 -12.20777 -12.31657
-2.625039 -1.548152 -5.970161 -6.712613
-3.907154 -4.066662 -7.884917 -8.673237
PP test Adj. t-stat.
-1.373234 -3.593835 -11.51255 -11.60163
-3.363331 0.829803 -2.795244 -5.304565
-1.056061 -3.279851 -12.80947 -13.55647
-2.393210 -1.561448 -6.000232 -6.729829
-3.915366 -3.882794 -8.118709 -8.730287
KPSS
LM-stat.
test
0.844207 0.192239 0.307608 0.117893
0.848064 0.278239 0.873644 0.097589
0.808705 0.199456 0.226863 0.103752
0.385172 0.270029 0.604160 0.084551
1.058882 0.172734 0.444075 0.107207

Table 1. Standard unit root test results

Source: Authors

The unit root tests results in Table 1 show that non of the variables under con-
sideration is integrated of order two I(2). Since all of the observed variables are
stationary I(0) or integrated of order one I(1), we firstly examine the Croatian

624
current account under absorption approch. Therefore, The dependent variable
in equttion (4) is current account (CA) and independent one is domestic de-
mand in Croatia (D). The estimates are provided in Table 2.

Variable Estimate t - value p - value

Intercept -0.12970 -3.605 0.000630
(0.03598)
-1.00902 -4.163 0.000100
(0.24236)
-2.13721 -3.631 0.000579
(0.58859)
-2.32241 -3.860 0.000277
(0.60172)
1.26568 2.975 0.004198
(0.42549)
0.63846 1.738 0.087282
(0.36738)
Residual standard Adjusted R-squared: F-statistic: p-value:
error: 0.03338 0.2984 6.615 5.589e-05
Asymmetric Cointegration test (Bounds Test):
Critical values I(0) I(1) F statistic
10% 3.17 4.14
6.614633
5% 3.79 4.85
2.5% 4.41 5.52
1% 5.15 6.36
Asymmetry statistics
Wald F-statistic: 4.836384 p - value: 0.03166624

Table 2. NARDL estimates of the croatian current account under absorbtion approach.
Source: Authors

Following the estimates in Table 2, domestic demand in Croatia and Croatian

current account are asimmetricaly cointegrated. The influence out of domestic
demand is significant at usually accepted siginificance level in short–run as
well as in long-run. Furthermore, the influence from domestic demand to cur-
rent account in short–run as well as in long-run is more prominent in case of
decline in domestic demand comparing to influence out of increase in domestic
demand. But nonetheless, there might be an influence from monetary sector to
Croatian curren account. In this paper three variables representing monetary
sector are examined. However, the estimated model exibited multicolinearity
in independent variables. Therefore, three model specifications are provied.
The each model takes into account one monetary variable (Loans to private
sector, montetary aggregates M4 and Real effective exchange rate index) while
holding domestic demand as the second independent variable in each model.

625
So, the first model specification aims to explain the dynamics in Croatian cur-
rent account with domestic demand and loans to private sector and the esti-
mates are summarized in Table 3.

Variable Estimate t - value p - value

Intercept -0.13146 -3.635 0.000598
(0.03616)
-1.09948 -4.429 4.35e-05
(0.24826)
-2.60230 -4.037 0.000163
(0.64460)
0.11653 1.622 0.110293
(0.07184)
-2.38685 -3.578 0.000716
(0.66716)
-0.04518 -0.309 0.758232
(0.14608)
1.38489 2.981 0.004214
(0.46450)
0.04820 0.051 0.959867
(0.95368)
0.46291 1.193 0.237646
(0.38789)
0.35051 0.344 0.732140
(1.01903)
Residual standard Adjusted R-squared: F-statistic: p-value:
error: 0.03342 0.2968 4.096 0.0004259
Asymmetric Cointegration test (Bounds Test):
Critical values I(0) I(1) F statistic
10% 3.17 4.14
5% 3.79 4.85 4.095545
2.5% 4.41 5.52
1% 5.15 6.36
Asymmetry statistics
Wald F-statistic: 16.80451 p - value: 0.0001328319

Table 3. NARDL estimates of the relationship between croatian current account,

domestc demand and loans to private sector.
Source: Authors

626
Following the estimates reported in Table 3, asimmetric cointegration is still es-
tablished and confirmed but the effects from loans to private sector is not found
to be significant. The other monetary variable considered in this paper is the
variable representing montetary aggregates M4. Table 4 provides the estimates
for the model specification where the Croatian current account is the dependent
variable while montetary aggregates M4 and domestic demand represent the
independent variables.

Variable Estimate t - value p - value

Intercept -0.12867 -3.267 0.001927
(0.03938)
-1.15701 -3.565 0.000790
(0.32452)
-2.58122 -3.073 0.003370
(0.83995)
0.06275 0.384 0.702820
(0.16358)
-2.37867 -2.840 0.006419
(0.83747)
-0.69209 -1.751 0.085789
(0.39518)
0.38414 1.818 0.074878
(0.21133)
2.68355 3.205 0.002313
(0.83743)
-0.91793 -3.400 0.001301
(0.26997)
-1.12742 -2.405 0.019769
(0.46879)
0.43012 1.626 0.110102
(0.26461)
1.61103 2.115 0.039214
(0.76161)
2.08280 3.532 0.000873
(0.58964)

627
 1.49200 2.093 0.041249
(0.71286)
0.13298 0.166 0.868581
(0.79972)
Residual standard error: Adjusted F-statistic: p-value:
0.02613 R-squared: 7.254 5.062e-08
0.5702
Asymmetric Cointegration test (Bounds Test):
Critical values I(0) I(1) F statistic
10% 3.17 4.14
5% 3.79 4.85 7.253781
2.5% 4.41 5.52
1% 5.15 6.36
Asymmetry statistics
Wald F-statistic: 8.755591 p - value: 0.004637665

Table 4. NARDL estimates of the relationship between croatian current account,

domestc demand and monetary aggregate (m4).
Source: Authors

The results in Table 4 point that taking into account montetary aggregates M4
the model improved. The asymmetric cointegration is established and con-
firmed. Compering to estimates in Table 2, explanatory power of the model
presented in Table 4 is almost doubled. Adjusted R-squared for the specifica-
tion presented in Table 2 amounts 29.84 while the reported Adjusted R-squ-
ared for model specification reported in Table 4 amounts 57.02. As expected
the influence out of monetary sector is more prominent in a short –run. The
third variable representing monetary sector is real effective exchange rate.
Threrefore, the model specification where the Croatian current account is the
dependent variable while real effective exchange rate index and domestic
demand represent the independent variables is reported in Table 5.

628
 Variable Estimate t - value p - value
Intercept -0.1272303 -3.578 0.000714
(0.0355545)
-1.0598627 -4.294 6.89e-05
(0.2468084)
-2.4781623 -3.624 0.000618
(0.6837282)
-0.0001731 -0.001 0.999566
(0.3170656)
-2.2143498 -2.824 0.006524
(0.7841212)
-0.4278856 -1.967 0.054019
(0.2174958)
1.5322131 2.624 0.011137
(0.5839569)
1.0916777 1.314 0.194019
(0.8306321)
0.5833632 1.490 0.141635
(0.3914168)
-0.8749961 -1.100 0.276006
(0.7955349)
Residual standard error: Adjusted F-statistic: p-value:
0.0321 R-squared: 4.97 6.155e-05
0.3513
Asymmetric Cointegration test (Bounds Test):
Critical values I(0) I(1) F statistic
10% 3.17 4.14
4.970462
5% 3.79 4.85
2.5% 4.41 5.52
1% 5.15 6.36
Asymmetry statistics
Wald F-statistic: 15.5693 p - value: 0.0002205716

Table 5. NARDL estimates of the relationship between croatian current account,

domestc demand and real effective exchange rate index.
Source: Authors

Following the results in Table 5, the real effective exchange rate helps to ex-
plaine Croatian current account dynamics. However, the explanatory power of
model specification in Table 5 is not as much improved as in case reported in
Table 4. Similarily, effects of real effective exchange rate is more prominent in a
short-run. All of the estimated model specification passed he diagnostic tests.12

1 Results available upon request.

629
Conclusively, Croatian current account is quite well explained under monetary
and absorption approach. The influence aout of monetary sector is more pro-
minent in a short-run. However, the absorbtion approach seems to be the one
that dominates. Unexpectedly, the best monetary variable to explain Croatian
current account is the one representing montetary aggregates M4 over GDP
since the real effective exchange rate index is a direct measure of relative pric-
es. Here needs to be stated that this paper employed the index real effective
exchange rate and results might be better when real effective exchange rate
in levels are observed. This is the limitation of this research. Eventually, there
might be the following conclusion. If the level of montetary aggregates M4 con-
tributes more to current account than real effective exchanange rate then there
might be liquidity constraints. Therefore, relaxing more liquidity could help to
improve Croatian current account. However, this remains to be empiricaly con-
firmed by another research.

5. Concluding remarks
There are several conclusions that can be drawn out of the research presented
in this paper. Firstly, as suggested by the results of the research presented
in this paper Croatian current account is well explained under monetary and
absorption approach. Secondly, the research results revealed significantly dif-
ferent responses of Croatian curren account to postive and negative change in
its determinants. NARDL approach employed in this paper revealed nonlinear
and asymetric long-run and short-run relationship between Croatian current
account and its determinant. Eventually, Croatian current account is the most
responsive to change in montetary aggregates M4, among tested variables.
Besides montetary aggregates M4, the variable tested in this research are real
effective exchange rate index and loans to private sector. The paper points on
the potential existence of liquidity constraints in Croatia and calls for further
research to prove that empiricaly.

630
REFERENCES

Aristovnik, A. (2008) “Short-Term Determinants of Current Account Deficits:

Evidence from Eastern Europe and the Former Soviet Union“ Eastern
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 CHAPTER 36

Cryptocurrencies: A critical review of

concepts and definitions

Admir Čavalić, Saliha Čabro, Faruk Hadžić

ABSTRACT

Blockchain technology enabled the development of BitCoin and other cryptocurrencies

that created the potential for further economic decentralization. Most of the cryptocur-
rencies are created by individuals, organizations, and companies, which implies that
there is still no clearly defined regulator and regulation in this area. This is precisely the
basic characteristic of the cryptocurrencies and refers to the absence of central authority
for the emission and management of these currencies. There are currently more than
1300 cryptocurrencies in the world, with a clear tendency for their growth. This is hap-
pening regardless of their volatility and possibility of collapse for some cryptocurrencies.
These trends are present globally and are slowly starting to develop in the Western
Balkan countries. In this paper, cryptocurrencies represent the central research topic.
Through the critical analysis of this concept, the aim is to clarify the different interpreta-
tions of the same, along with the blockchain technology on which cryptocurrencies are
based. In addition, the paper presents the main features of the cryptocurrencies, with
the potential of their growth, and the challenges that accompany them. Paper also offers
analysis of the potential of blockchain technology. In the end, an appropriate conclusion
will be made, with recommendations for improvement in this area.

Key words: Cryptocurrencies, blockchain technology, BitCoin

JEL classification: O3, O32, E49

1. Introduction
Today’s world is marked by the development and intensive use of the blockchain
technology, which maximizes the potential of existing technologies in order to
improve global business. This is the next level of globalization, which involves
decentralizing power and further reducing the impact of time and space on
global transactions. The flagship of these new trends is BitCoin, the pioneering
and most famous cryptocurrency. Right now, this is the only true mainstream
cryptocurrency that attracted even the biggest sceptics among its investors in
2017 with its growing market value. BitCoin but also the other cryptocurrencies,
whose number exceeds a thousand, are the voices of new tendencies, primarily
in business, but certainly also in technology. This trend will change the world as
we know it and enable better integration of the rest of the world into the current
economic trends. It is therefore essential to understand the main characteristics

633
of these new trends, but also their future perspective. The paper will present the
trend of decentralization, and the way blocking technology works, as well as the
future of the application of this technology, together with the cryptocurrencies
that are the direct result of blockchain technology.

2. Decentralization trend
Blockchain technology, bitcoin and other cryptocurrencies are an integral part
of a wider trend of decentralization that has been going on since the early
years of the Internet, but for the past two decades at an extraordinary pace.
According to Frank Holmes (2018), a contributor to Forbes magazine, this has
been called a number of things: The sharing economy, or “shareconomy.” Peer-
to-peer economy. Collaborative consumption. What all of these terms have in
common is the idea of decentralization — and blockchain applications, includ-
ing bitcoin and other cryptocurrencies, are just the latest in a trend toward this
new economic paradigm. The basis of the new economic paradigm is decen-
tralization, which means the reduction of the power of the one single centre,
was opposed to creating more around the world. All this is possible thanks
to new technologies, primarily the Internet (Sharma, 2014), which summarize
space and time, as Harvey points out (Harvi, 2014). Decentralization is the pro-
cess of distributing or disseminating functions, powers, people or things away
from a central location or authority (The Economist, 2009).
In addition to economics, this also happens in politics, so “the future now de-
pends on the continued commitment to the ethos of decentralization, the idea
that even in politics, the customer is always right” (Kibbe, 2012: 332). These
trends are generally viewed positively as decentralization leads to greater free-
dom of business and the individual (Hayek, 2013: 32), which ultimately leads to
prosperity and economic democracy (Algar, 2006; Buczynski, 2013). This trend
is often referred to as the sharing economy, which implies greater participation
(Sajter, 2014) on both sides - supply and demand, with the maximum utilization
of available resources.
The sharing economy is defined as an umbrella concept that includes several
information and communication technologies and technologies, among others,
collaborative consumption, which encourages the sharing and consumption of
goods and services through the Internet platform (Juho et al., 2016). Collab-
orative consumption can be defined as “a form of consumption that promotes
co-operation between individuals and develops a sense of community and en-
courages a sense of commitment” (Vaquero and Calle, 2013). Bitcoin as such
is considered as part of the sharing economy (Oxyang, 2014; Frodesjak et al.,
2011), or as a technology that will revolutionize the entire sharing economy,
making the missing puzzle. Although sharing has always existed as such, these
phenomena have emerged in the era of the Internet (Belk, 2014) and are linked
to the greater consumerism of Internet technologies (Sundararajan, 2011). The
Internet is a medium of unseen opportunities (Huseynefendić, 2011) and regu-
lation, in this case, is not, nor can it be a solution (Malhotra, 2014).

634
3. Blockchain and bitcoin
According to Thomas Kuhn’s theories, it is clear that the research of block-
chain technology is still in the pre-paradigm phase characterized by a number
of incomplete, competitive theories that compete in the scientific community
for primacy, for the position of the new paradigm (Letica, 2010). As with the
sharing economy, blockchain technology seeks to give power to individuals
by creating no need for intermediaries. Again, paraphrasing Drucker, the con-
sumer becomes the one who determines what the company is (Drucker, 2008).
Blockchain technology implies the existence of information blocks that record
transactions. Records are kept by members of the network, who are reward-
ed through the process of “mining” (cryptocurrency mining). Unlike the clas-
sic transaction that requires a bookkeeper to register in the ledger, blockchain
technology rests on a mathematical algorithm that cannot be influenced. Block-
chain ensures the transparency and integrity of transactions purely through
mathematics, and not trust. The type of transaction varies depending on the
application of blockchain technology. For bitcoin, as an example, each transac-
tion is a transfer of a certain value of bitcoin between two or more participants,
and each transaction is recorded on the bitcoin blockchain (Vairaprakash
et al., 2018).
The history of cryptography actually begins in the 80s, but only blockchain tech-
nology will really solve the issue of double spending. BitCoin’s history is marked
by links to crime (Silk Road, CrptoLocker and others) (Bonneau et al, 2015).
For the first time, the word bitcoin appears in a paper published on October 31,
2008, by Satoshi Nakamoto. The first block that was made is called genesis
block. Currently, it counts as block 0. The message on the block has listed the
following: The Times 03 / Jan / 2009 Chancellor on the brink of the second
bailout for the banks. This is the title of The Times magazine that came out on
January 3, 2009. The title refers to the global financial crisis that hit the banking
sector and caused government rescue of banks. This appeared to be a trigger
for the rise of cryptocurrencies.
There are two basic reasons for the emergence of bitcoin in the context of the
global financial system. Satoshi Nakamoto, who is considered the founder of
bitcoin in his scientific work in which he presents this cryptocurrency, states that
the global system of financial transactions has two deficiencies - high trans-
action costs and distrust, that is, the possibility of fraud (Nacamoto, 2008). In
essence, Bitcoin, but also other cryptocurrencies try to eject third parties in
electronic transactions. So there is a system of electronic transactions that do
not rely on trust. This is unique for bitcoin, which still falls within the domain of
the sharing economy. Because of that, the biggest potential of bitcoin is that it
solves the problem of double spending. It is because of that, that bitcoin today
is a worldwide payment system and a first decentralized currency. The whole
system operates without a central bank or any other kind of centre adminis-
trator. Bitcoin is a collection of concepts and technologies that form the basis
for digital money ecosystem (Antonuopoulos, 2014: 1). Bitcoin is used to store

635
and transfer values ​​among bitcoin market participants. At the same time, user
interaction takes place using special bitcoin protocols, which most often work
on the Internet. Bitcoin can be used in any other currency. Antonupoulos (2014)
states that with bitcoin, an individual can buy and sell goods, send money to
people or organizations, or extend credit. Bitcoins can be purchased, sold, and
exchanged for other currencies at specialized currency exchanges. Bitcoin in
a sense is the perfect form of money for the Internet because it is fast, secure,
and borderless (Bonneau et al., 2015).
Several factors determine bitcoin: (1) the price of electricity; (2) state of glob-
al and local economies; and (3) other socioeconomic factors (Mehta, 2018).
Bitcoin network requires exceptional power levels, which even causes BitCoin
miners to migrate to sources of cheaper energy, such as e.g. Oregon in the
United States. Electricity also affects transaction costs when it comes to Bit-
coin. At the end of 2017, the global bitcoin mining activity was estimated to con-
sume between 1 and 4 gigawatts of electricity (between 9 and 35 TWh a year),
with 1.2 GW as the theoretical lower bound assuming that everyone uses the
most energy-efficient mining hardware available (Mooney and Mufson, 2017).
Another aspect of the impact is the situation of global and local economies. Ma-
jor events, such as the global economic crisis, have a significant impact on the
demand for bitcoin and other cryptocurrencies. In addition, any other uncertain-
ty about conventional world currencies increases the demand for alternatives
like bitcoin. The effect is also the opposite, ie. in case of economic stability. In
crisis situations, bitcoin serves as value storage, although this is still question-
able and problematic due to the very nature of this cryptocurrency. In addition,
there are many other options for storing value ​​on the market.
Another impact on bitcoin is that of local economies. In particular, the fact that
the local government can issue a regulation against bitcoin can affect its value.
So, for example, some governments have threatened or otherwise discussed
crypto-regulation. For example, in September 2017, China threatened to close
crypto exchanges. The legal status of bitcoin varies considerably from country
to country and is still undefined or changing in many of them. While some coun-
tries have explicitly allowed its use and trade, others have banned or restricted
it. Regulations and bans that apply to bitcoin probably extend to similar crypto-
currency systems also (Tasca, 2015).
Bitcoin carries a series of social consequences and affects the behaviour of
an individual, non-governmental organizations and the state. The economic
aspect of bitcoin is in line with Milton Friedman’s theories about a certain annu-
al increase in money in circulation. When it comes to environmental aspects,
bitcoin supports eco-innovation, while on the other hand, it consumes a lot of
electricity that indirectly threatens the environment.

636
4. Future of blockhain
Although we are at an early stage of the new paradigm, much is expected from
blockchain technology (Holmes, 2018). What is likely to happen is that block-
chain technology will further empower the sharing economy and make it more
efficient. It will reduce the cost of resources and the need for individual owner-
ship over it. This will affect the increase in the discretionary budget and the time
available to consumers, which will allow capital and time for new innovations,
leisure, and other needs (Killeen, 2016). A particular problem will be related to
the issue of taxation (Buntinx, 2015). With the rise of numbers of this kind of
transactions, governments will have a stronger interest in putting it into legal
frameworks and taxing to preserve fiscal stability. Blockchain technology will be
used more significantly by the government also. Right now there are countries
in the world that embarked on a project to implement blockchain technology in
the evolution of ownership rights (Shin, 2017).
There are several possible applications of blockchain technology in the future:
(New Gen Apps, 2018): (1) Dropping a third party for trust - this applies to any
kind of public records also; (2) increasing security by using blockchain tech-
nology; (3) greater capital investment in this technology, Deloitte predicts that
blockchain projects will overcome those in the field of cloud computing and
IoT in venture capital investments. (4) The most important feature of block-
chain is that it provides unsurpassed security in an unsecured Internet where
phishing, malware, DDOS, spam and hacks put in danger the way business is
done globally; (5) Application of blockchain for greater transparency of digital
advertising; (6) change of payment method, e.g. Micro contracts, smart pay; (7)
new ways of employing and changing the labour market. When it comes to the
sharing economy, blockchain will further empower it, helping a develop of con-
fidence for larger markets and more participants (Bradbury, 2014). Larger shar-
ing economy requires an autonomous, decentralized system that will provide a
component of trust. Predictions are that almost all business will be conducted
on a radically decentralized peer-to-peer level (Clifford, 2014).
It is interesting that the first major players and investors started to appear when
it came to these technologies, which the Forbes magazine regularly monitors
(Shin, 2018, Novack, 2018; Kauflin, 20189. Some of the other potentials of
blockchain technology include the integration of billions of people in global fi-
nancial markets, only by using their smartphones, as well as the elimination of
mediators in the form of bureaucracy when it comes to foreign aid (Tapscott et
al, 2016). Cryptocurrencies could become part of everyday life. Several people
will be enriched in this process, but not excessively much or more in com-
parison with the pioneers of some other computer technology (Hern, 2018).
Blockchain technologies are in the initial two stages, as stated by some authors
(blockchain 1.0 and 2.0). These stages are oriented on cryptocurrencies most-
ly. Now it is expected that blockchain 3.0, which implies the creation of real
applications that will be practical and act on the basis of blocking technology
(Inc., 2018).

637
5. Conclusion
The paper analysed the phenomenon of blockchain technology and bitcoin as
the most famous product of the same and presented the basic characteristics
of these concepts. A general trend of decentralization in society and politics
is happening, especially in economics and technology. Blochain technology is
in a natural symbiosis with the sharing economy, which in the long run will
have remarkable effects on the fiscal system. Governments will have to find
new modalities to integrate these trends into their economies. When it comes
to bitcoin, the question is what is the future of this cryptocurrencies. This will
remain unclear in the future, and many investors are already asking what will
happen to bitcoin in 2018. What is shown in the paper, is that blockchain tech-
nology is changing our world and economy? It is for this reason that for the
less developed countries of the world it is crucial to adapt to these new trends
because they can achieve higher rates of economic growth by their application.
The limitation of this paper is reflected in the fact that it can not, in the largest
capacity, encompass the essence of new technologies, as they are changing
and developing as the paper is being created. Therefore, continuous research
and monitoring of these development trends are recommended.

638
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Antonuopoulos A., (2014), Mastering Bitcoin: Unlocking Digital Cryptocurren-

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1595–1600.

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639
 CHAPTER 37

The bail-in principle – responsible banks

for a sound financial system

Jovan Zafiroski

ABSTRACT

Since January 2016 the Single Resolution Mechanism became fully operational. As a
second pillar of the European banking union it should provide equal treatment of the
credit institutions when they are facing problems and when a bank failure is probable
or occurs. Also, the Single Resolution Mechanism contributes to broader objectives of
the banking union for achievement of deeper market integration and breaking the link
between the sovereigns and banks. The financial crisis from 2008 has shown that even
failures of the big international banks are possible. It is difficult to justify the situation
when the bank’s profits are always private and are distributed between the shareholders
and the management while loses are covered by taxpayers. This dilemma goes beyond
the problems of morality and has direct effects of the countries’ public finances and the
level of public debt. It is hard to justify the bank bail-outs. The negative consequences of
the problems facing credit institutions were more emphasized on the EU financial mar-
ket. The newly created Single Resolution Mechanism includes a solution to this problem
which puts the responsibility and consequences of the bank difficulties to the bank itself.
Thus, the newly created bail-in principle gives power to the resolution authorities to
cancel shares and to write down or to convert liabilities of a bank. The text explains the
bail-in principle and discusses the possible effects that it might have on the stability of
the financial sector in the Eurozone. Also, the effects of the digitalization of money and
the reduction of cash in the transactions are examined.

Key words: digital money, bail-in principle, bank failure, Eurozone, bail-out

JEL classification: G21, K39

1. Introduction
The financial crisis from 2008 has brought profound changes in the financial
infrastructure in the developed countries while provoking series of reforms in
the legal framework regulating the financial and monetary institutions. Unprec-
edented in its scale and scope in the recent decades the crisis has pushed the
markets and the regulators to their limits, menacing to endanger the existence
of the international financial order as we all know it. The bankruptcy of the Le-
hman Brothers (See: Williams M., 2010, 165-178) was a clear signal that even

641
the big banks might face difficulties and fail. In other words, there are no “stars”
in the financial systems and every single financial institution, no matter how big
and systemically important it is, may face the “Chapter 11”.
Also, the crisis has clearly shown that nowadays, in times when financial mar-
kets are highly integrated, the national response to problems is not enough
when the threat to the financial system is global. This is even more accented
in the EU before the crisis. The banks have had cross border activities while
the authorities for regulation and supervision were national. In other words,
the crisis was an unambiguous warning sign that either the EU will commence
profound reforms in the field of the financial services infrastructure or it will face
a collapse of the entire integration project. Thus, a broader reform of the Eu-
ropean financial system and the establishment of the Banking union including
the Single Supervisory Mechanism (hereinafter SSM), the Single Resolution
Mechanism (hereinafter SRM) and the Common Deposit Insurance Schemes
(hereinafter CDIS) has taken place.
While SSM provides a coherent supervision at the EU level the SRM should
ensure equal rules and procedures when a bank is facing difficulties and is like-
ly to fail. Different treatment of a failing bank might undermine the competition
and put in danger the functioning of the internal market with the four freedoms
as its core element.
As far as bank failure is concerned two questions are the most important. Who
is responsible for conducting the process of resolution and who carries the
costs of the bank failure? Before the crisis national authorities were responsible
for bank resolution while a common response to a systemic banking crisis was
a bail-out of the banking sector which involves public finances. The bail-out
might consist of different instruments and procedures for intervention including
government takeovers, purchases of bad assets, mergers of financial institu-
tions etc. However, the cost of the banking crises goes far beyond the sim-
ple numbers of the bank bail-out. It includes the costs of the overall economic
downturn in both the financial and real sector which is difficult to be measured
in its entirety. The history teaches us that along with the direct cost for bank
bail-out the negative impact of the bank crisis on the public revenues is consid-
erable (See: Reinhart C., Rogoff K., 2009, 163-171).
With different interventions on the financial markets, primarily by capital injec-
tions to problematic banks and by guarantees on the deposits to prevent bank
runs, the recent crisis has put enormous pressure on the public finances in the
EU Member States. The indirect costs are difficult to be measured while the
numbers are saying that the EU Member States have intervened with large
amounts of money. This raises a series of questions about the moral aspects

642
of spending public money for saving private institutions which in normal times
were making huge profits for shareholders and premiums for the management1.
The financial crisis had significant impact on the financial institutions in the
EU. To reduce the negative effects of the crisis and to restore confidence, EU
governments provided State aid to financial institutions through different in-
struments such as recapitalizations, impaired asset measures, guarantees on
liabilities liquidity measures other than guarantees on liabilities etc. The data
relating to the State aid to financial institutions in the years 2008-2015 shows
that the overall amount of state aid approved was above 5 trillion Euros while
amounts of state aid used was around 2 trillion euro (European Commission,
2016). Considering the financial costs of the bailing out and financial aid for
the troubled financial institutions for the public finances and ultimately for the
taxpayer’s money the need for a new model dealing with a failing institution was
undisputable. Banks could no longer be permitted to be European in life but
national in death (Boccuzzi G., 2016, pg.15).
The text will present the newly established bail-in principle (2) as a pillar on the
foundations of the SRM (1) while also discussing some important legal ques-
tions deriving from the implementation of bail-in principle as the principle of
protection of property (3). Also, the last part (4) will consider the effects on the
dematerialization of money on the implementation on the bail-in principle. The
paper does not go into details about the rules and procedures of the bail-in as
a resolution tool but gives an overview of this instrument which is somehow a
revolution in the resolution process of a failing financial institution.

2. The foundations on the new resolution mechanism

The newly created SRM should provide a unique treatment of institutions
which are facing bad times. Different rules and procedures for bank resolution
could bring differences in treatment of the failing bank depending on the mem-
ber state where resolution is taken. Therefore, in some cases, the decision
on the establishment or on certain business activities might be taken on the
grounds of facts determining which Member State provides better conditions
for a failing credit institution. This will undoubtedly undermine the competition
and the principle of equal treatment of the European financial operators. The
SRM is a unique mechanism that includes supranational bodies and national
resolution authorities. The legal framework regulation the SRM consists the

1 Also, the state intervention in the banking sector for bailing out systemic important banks is
problematic from legal point of view in terms of competition policy and state aid rules. The fear from
disaster in the financial sector was too great that even the EU did not take serious measures to
limit the state aid in the financial institutions and to make profound analysis on the mergers in the
financial sector (See: Marsden P., Kokkoris I., 2012, 331-336)

643
Recovery and resolution Directive2 (hereinafter: the Directive) and the Regu-
lation establishing uniform procedures for resolution on the credit institution3
(hereinafter: the Regulation).
The Directive sets the resolution objectives which requires that the resolution
process ensures the continuity of the critical functions of the financial institution,
protection of public funds by minimizing reliance on public financial support,
protection of depositors, protection of client funds and assets4. The conditions
for resolution are laid in the Directive’s provisions demanding certain conditions
to be met before resolution process might be undertaken. Thus, the determina-
tion if the credit institution is failing or is likely to fail has been made by compe-
tent authority, there is no private sector solution for the credit institution and if
the resolution action is necessary in the public interest5 and there is a replace-
ment of the management body and senior management of the institution under
resolution which should provide all necessary assistance for achievement of
the resolution objectives6. General principles governing resolution requires that
the shareholders of the institution bear first loses, creditors of the same class
are treated equally, and they bear loses after shareholders, while covered de-
posits are fully protected. At the end of the resolution process no creditor shall
incur greater loses than he would have under normal insolvency proceedings.
The resolution procedure is defined in the Directive where there are three dif-
ferent phases. The first stage is the preparatory phase; the second phase is the
early intervention while the third stage is the resolution stage. The resolution
tools include: the sale of the business tool, the bridge of the institution tool, the
asset separation tool and the bail-in tool7. The novelty in the resolution tools
deemed as a ”revolution” in the resolution process which will make the credit
institutions more responsible and will protect the public finances from excessive
debt created by bail outs of the banks is the bail-in tool and it will be elaborated
in the next part of this article.

2 Directive 2014/59/EU of the European Parliament and of the Council of 15 May 2014 estab-
lishing a framework for the recovery and resolution of credit institutions and investment firms
and amending Council Directive 82/891/EEC, and Directives 2001/24/EC, 2002/47/EC, 2004/25/
EC, 2005/56/EC, 2007/36/EC, 2011/35/EU, 2012/30/EU and 2013/36/EU, and Regulations (EU)
No 1093/2010 and (EU) No 648/2012, of the European Parliament and of the Council, available at:
http://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:32014L0059&from=EN
3 Regulation (EU) No 806/2014 of the European Parliament and of the Council of 15 July 2014 es-
tablishing uniform rules and a uniform procedure for the resolution of credit institutions and certain
investment firms in the framework of a Single Resolution Mechanism and a Single Resolution Fund
and amending Regulation (EU) No 1093/2010, available at: http://eur-lex.europa.eu/legal-content/
EN/TXT/PDF/?uri=CELEX:32014R0806&from=EN
4 Article 31 of the Directive
5 Article 32 of the Directive
6 Article 34 of the Directive
7 Article 37 of the Directive

644
3. The bail – in principle
As in every other business, banks may face difficulties and go into default. That
means that there will be more room for other credit institutions that are working
better. They are more efficient, innovative and that is why they will continue
and expand their activities (See: Nouy D., 2017). To be out of the business
is a normal phenomenon. A failure of a bank is a signal for well functioning of
the financial system. If the financial infrastructure is well designed a failure of
one bank should not pose a problem to the entire financial system. However,
a problem arises, as in 2008, when a failure of one bank might undermine the
well-functioning of the entire financial system. The trust in the system and the
institutions for control and supervision is eroded while panic is spread. Usually,
the state is faced to difficult choices. To let the bank fail with risk to endanger
the functioning of the system or to save the bank with public money and to
continue the work as usual. In fact, the theory offers two different concepts for
dealing with a failing bank. The opposing theoretical concepts: liberal vs. inter-
ventionist. The former states that the bank should be left to the forces of market
and let to fail while the position of the latter is that the authorities should inter-
vene and protect the stability of the overall financial system. In times when the
problems of one banks are spreading to other financial institution the common
choice is intervention. As explained before, the intervention means huge cost
for the public finances and poses moral dilemmas about the different treatment
of the banks in good and in bed times. When they have profits they are private
institution but when it comes for loses they are covered by the state.
The first attempt to solve this problem and to limit the government intervention
with public money to save private banks was in the case of Cyprus. In 2012, the
banking sector in Cyprus or the country’s two largest banks were facing difficult
times and was clear that they need financial aid to continue with their work and
to avoid failure which might provoke collapse of the entire financial and eco-
nomic system considering the fact that country’s banking sector is much bigger
than its GDP. The financial assistance for troubling banks in Europe was of-
fered before though different mechanisms. It was the case with banks in Island,
Ireland, Spain, Greece etc. However, in order to preserve its macroeconomic
stability and to keep the public finances in good condition the Cypriot authorities
together with the EU institutions proposed unusual measure at that time i.e. use
of funds from uninsured bank depositors for helping the troubled institutions. It
was very different situation from what we have previously seen and has rarely
occurred in the financial history. The solution has been deemed as a form of
taxation or as a modern “nationalization” of the bank deposits (See: Zafiroski
J., 2013). At that time, strange and unusual but this mechanism become one of
the core elements in the further reform process and the creation of the SRM.
The most important novelty brought by the bail-in principle is that when a bank
fails it is the banks’ shareholders and creditors that bear the costs. The main
purpose of the bail in principle is to break the link between sovereigns and fi-
nancial institutions in trouble putting pressure on the bank’s management and

645
shareholders to be more responsible for their own decisions. Thus, the man-
agement and shareholders cannot be sure that the bank will be rescued with
public money when things go wrong while earning big returns when things go
well. This mechanism will also reduce the risk that the banks are ready to take
when taking decisions.
At the essence of the bail-in objectives is the reshaping the bank balance sheet
provided that the financial institution under resolution has a positive net value.
To achieve this the competent authority might decide that equity holders or ex-
isting shares or other instruments of ownership are cancelled or transferred to
bailed-in creditors or, as far as the debt holders are concerned, the competent
authorities might convert liabilities8, bonds for instance (Spiegeleer De J. and
al.,2014), into shares or other instruments of ownership9.

4. Challenges to the traditional legal principles and the

fundamental right to property
The role of the State in the financial sector is to protect the soundness and
well-functioning of the system as well as to promote competition. The recent
financial crisis has shown that the public finances could suffer by excessive
use of the taxpayer’s money that are used to save the systemic important in-
stitutions in order a collapse of the entire financial and economic system to be
avoided. The bail-in is a useful tool in this respect. However, it opens series of
questions about the justification of these measures in view of the basic legal
principles as the protection of right to property. Measures such as bail-in deci-
sion which include cancelation or transfer of shares, suspension or conversion
of liabilities into shares are often contested by concerned individuals or compa-
nies on the ground on Article17 of the EU Charter of fundamental rights relating
to the right to property10. The Charter is applicable when EU institutions, bodies
and agencies are deciding and thus implementing EU law and national authori-
ties when are implementing the EU law. In the Case law of the European Court
of Human Rights it is established that company shares11 and debt instruments

8 All liabilities of a bank in resolution are eligible to the bail-in tool if they are not explicitly excluded
by the provisions of the directive (such as covered deposits, for example), see Article 44(2) of the
Directive
9 Articles 47 (1)(b) and 63 (1)(f) of the Directive
10 Article 17(1) of the Charter provides that: everyone has the right to own, use, dispose of and
bequeath his or her lawfully acquired possessions. No one may be deprived of his or her posses-
sions, except in the public interest and in the cases and under conditions provided for by the law,
subject to fair compensation being paid in good time for their loss. The use of property may be
regulated by law in so far as is necessary for the general interest. Also, Article 1 of Protocol No 1 to
the European Convention on Human Rights states that: Every natural or legal person is entitled
to the peaceful enjoyment of his possessions. No one shall be deprived of his possessions except
in the public interest and subject to the conditions provided for by law and by the general principles
of international law.
11 See: ECtHR, Sovtransavto Holding v. Ukraine, Appl. No 48553/99, paragraphs 90-93, available
at: http://hudoc.echr.coe.int/eng?i=001-60634

646
and liabilities deriving from them are falling in the category or in the scope of the
article 1 of the Protocol relating to the property rights.
From the legal point of view the limitations to the right to property should be
examined through proportionality test regularly used in the process of expropri-
ation. However, the bail-in ban not be qualifying for expropriation or “deprivation
of possession” simply because the process of writing down or canceling of
shares or of a liability is not a transfer of property from shareholder or creditor to
another person. The financial stability and fiscal protection is the public interest
on which grounds the limitation of the right to property is justified in the case of
using bail-in tool (Wojcik K-P., 2016).
Moreover, in its recent judgement12 concerning State aid rules to support meas-
ures in favour of banks in the context of the Slovenian banks the Court found
that the right to property must be interpreted as not precluding the Banking
communication (European commission, 2013) in respect to the points 40-41
stating that “state support can create moral hazard and undermine market dis-
cipline. To reduce moral hazard, aid should only be granted on terms which
involve adequate burden-sharing by existing investor”. Therefore, “since share-
holders are liable for the debts of a bank up to the amount of its share capital,
the fact that the Banking Communication requires that, in order to overcome the
capital shortfall of the bank, prior to the grant of State aid, those shareholders
should contribute to the absorption of the losses suffered by that bank to the
same extent as if there were no State aid, cannot be regarded as adversely
affecting their right to property”13. This judgment is a clear confirmation that the
bail-in as a resolution tool cannot be perceived an instrument undermining the
right to property.

5. New technology, dematerialization of money

and the bail-in principle
In the last period there are certain trends in the monetary field that are in favor
or against the bail-in principle and have influence on its efficiency in delivering
expected results. Those trends are related to the use of the new technologies
in the payment systems and to the process of dematerialization of money. Also,
the effects form the crisis are present in some of the developed countries while
the measures taken in that period are still in place which has certain effects on
the possible success of implementation of the bail-in principle in the bank res-
olution process. Thus, there is a general trend of dematerialization of money.
Some authors even consider cash as redundant in the economy (Rogoff K. S.,2016).

12 Case C526/14, JUDGMENT OF THE COURT (Grand Chamber) of 19 July 2016, REQUEST
for a preliminary ruling under Article  267 TFEU from the Ustavno sodišče (Constitutional Court,
Slovenia), made by decision of 6 November 2014, received at the Court on 20 November 2014,
available at: http://curia.europa.eu/juris/document/document.jsf?text=&docid=181842&pageIndex-
=0&doclang=EN&mode=req&dir=&occ=first&part=1&cid=95988
13 Court of Justice of the European Union, PRESS RELEASE No 80/16 Luxembourg, 19 July 2016,
pg. 2, available at: https://curia.europa.eu/jcms/upload/docs/application/pdf/2016-07/cp160080en.pdf

647
According to this position all the transactions should be made through elec-
tronic payments while the cash might be used in transactions on very small
amounts. There are many arguments for this: combat against tax evasion,
money laundering, financing of terrorism etc. This process creates a situation
in which all the money in the economy are “visible” in the banking system. The
money is on current accounts, deposit accounts etc. which makes a possible
use of the bail-in principle efficient. This trend of dematerialization of money
goes in favor of the bail-in principle. However, there are two other trends that
are making the success of the implementation of the bail-in principle less likely.
The use of technology and the launch of cryptocurrencies as means of pay-
ment makes the use of the bail-in principle inefficient. The cryptocurrencies are
outside the traditional payment system and are not part of the system of bank
deposits. They are not “visible” for the authorities while the transactions and
owners of the funds are anonymous. Also, another factor which a result of the
current monetary policy, most notably in the Eurozone, could jeopardize the
success of the possible use of the bail-in principle. Namely, the real interest
rates on bank deposits in certain economies are negative which makes cash
more attractive than bank deposits. Banknotes have 0% return while certain
deposits have negative return which is unprecedented in the monetary and
banking history, but we are witnessing today. When one will also consider the
fact that deposits might be subject to bail-in in case of bank failure the cash is
even more attractive.

6. Conclusions
In the aftermath of the financial crisis profound reforms in the financial infra-
structure in the EU has been undertaken. The result is more competences
on European level for many important issues relating to the financial system.
From institutional point of view the creation of the European banking union
implies transfer of powers to the supranational institution and cooperation with
the national authorities responsible for supervision and resolution of the credit
institutions.
The crisis from 2008 had significant impact on the public finances in the Mem-
ber States. Vast amounts of money were spent by Governments and EU in-
stitutions on bailing out the systemically important banks in in Island, Ireland,
Spain Greece etc. The authorities were forced to save this institutions with
public money in order to preserve the stability of the overall financial system.
The bail-out opened a series of debates about the moral hazard problem with
saving the big banks. The current mode of the global financial system can not
let banks to be private when making profits while public good and bailed out
when facing loses.

648
The most important novelty in the resolution process on European level is the
bail-in principle that gives powers to the resolution authorities to cancel shares
and to write down or to convert liabilities of a bank. Thus, if a bank fails it is the
banks’ shareholders and creditors that bear the costs.
The main goal of the bail-in tool is to reduce the risk that the management of
the bank is ready to take. By putting more pressure on the bank’s management
and shareholders will be more responsible for their own decisions. Thus, the
management and shareholders cannot be sure that the will be saved with tax-
payer’s money when things go wrong. Similar resolution tool was successfully
used during the crisis in the banking sector in Cyprus in 2012.
However, even if the bail-in principle may look like a revolution in the resolution
process that will break the vicious cycle between the governments and the sys-
temically important banks it has been challenged by the core legal principles as
the fundamental right to property.
Also, there are certain trends in the monetary field that go in favor of the suc-
cessful use of the bail in principle as is the case with the process of dematerial-
ization of money. However, there are also some developments as it is the case
with the use of the cryptocurrencies and the negative interest rates that are mak-
ing the possible implementation of the bail-in principle much more difficult task.

649
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