Brazil: Consumer Fever – and Some Headache

SÃO PAULO – It has been known for years that Brazilians are crazed shoppers – and not ashamed to be described as such. In spite of the lingering crisis environment, Brazilians frequently show up as the most optimistic consumers in Latin America, if not the world, as Credit Suisse recently pointed out in its recent survey of emerging markets.

Brazilian customers are keen on smart phones and computers, absolutely love shopping malls and ocean cruises. Young couples plan to purchase baby clothes in Miami and older ones take their kids to Disneyland – sometimes several times. Recently, though, it has been the expanding middle-class that has excited marketers of fast-moving consumer goods.

But some things never seem to change. While company executives try to make the most of the consumer boom, the cost of doing business still is much higher in Brazil than in most other Latin American countries because of deficiencies in transport and logistics, taxes and labor laws. This generally reflects in the price of goods – and the exchange rate.

Avenida Paulista, São Paulo

For years, São Paulo’s famed Avenida Paulista has been hosting banks and drugstores, but popular stores such as fashion chain Marisa, Renner or Hering recently have set up shop there to attract a chunk of the 1.5 million employees who pass by every day.

“This is a reflection of the improvement in the purchasing power of the population and of social mobility within São Paulo,” says Marcos Etchegoyen, president of Cetelem, a consumer finance company.  An impressive contingent of 64 million people has climbed up the social ladder since Cetelem, owned by BNP Paribas, and Ipsos Public Affairs, began conducting consumer surveys seven years ago in Brazil. That is roughly equal to the population of Italy, Etchegoyen notes.

New consumer

Tatiana Candido de Lima is a young member of the new, emerging middle class.  She works at Qualicorp, a private health-services provider that launched its IPO in June 2011, and she managed to quadruple her income since she got her first job five years ago. Like many Brazilian women, she can easily go on a spending spree.

Job creation and real income gains have boosted consumer confidence. The credit boom also helped: It went from a low 25 percent of GDP, when former presidente Luiz Inacio Lula da Silva came to power in 2003, to about 50 percent in less than 10 years. No wonder Brazil, which already is the world’s sixth-largest economy in nominal terms, has become the world’s third-largest market for computers and the fourth-largest for cars. Banks and retailers – such as Casas Bahia and Ponto Frio– have made the most of it. Brazil has become the largest market for Carrefour outside its home country, France, and it is the second-largest for Nestle and other consumer-goods companies.

Home ownership, which has been encouraged by government programs such as Minha Casa, Minha Vida, also is increasing, thanks to low unemployment and long-term economic prospects after decades of domestic economic crises.

Economic stabilization in the 1990s after the Real Plan meant that the mass market started to have access to chicken and yogurt. Almost 20 years later, consumer demand has become more sophisticated.

Social and regional inequalities are still great, but they tend to become narrower. Economic growth has been especially strong in the northeast, the north and the center west of Brazil. The Pague Menos drugstore chain is a good example of this. Its president, Deusmar Queiros, started the business in the northeast region 30 years ago and now it is a 500-store chain, still with a stronger presence in the northern half of the country.  “Here the Bolsa Familia (government benefits to poor families) makes a big difference,” Queiros says. “And there is also a larger proportion of the population that relies on the minimum wage,” like low-skilled workers and rural pensioners in the Northeast. The Fortaleza-based chain intends to launch 100 drugstores this year, compared with 89 last year, Queiros says.

The future also looks bright for companies such as the chocolate shop Cacau Show. The firm  started in the late 1980s, but it has really taken off in the past five years, when its sales shot up by 45 percent per year on average (450 million reais – about $150 million – in 2011). Business has been booming, and the relaxed 41-year-old CEO, Alexandre Costa, says he has prepared a standard e-mail to decline offers from private equity investors.

Indeed, consumer goods have become the main target of foreign investors in Brazil, according to Paulo Bilyk, a partner at Rio Bravo Investimentos. “There is some kind of love affair with consumer-good assets, which is reflected in the prices of shares of companies like Arezzo, Marisa and Perdigão. Private equity funds have kept a close eye on them,” says Bilyk.

‘Custo Brasil’ alive and kicking

Nevertheless, exploring the expanding Brazilian market still comes at a price, and the business environment has remained remarkably difficult, if not hostile.

Brazil has fared badly in the World Bank’s annual “Doing Business” survey, putting the country at a disadvantage against its main competitors worldwide. The latest survey ranks Brazil 126th among 183 countries, including a dismal 150th in the “paying tax” category.

CFOs in multinationals operating in Brazil usually express a lingering concern – if not frustration – regarding tax complexity and compliance issues in Brazil, which often is described as the most critical case in the region. Almir Barbassa, CFO of Petrobras, the oil company, notes that 900 people are employed in Petrobras’ tax department.

Jorge Gerdau, chairman of Gerdau, the steel group, has complained that companies in Brazil typically need 2,000 hours to comply with their tax obligations. He is now part of a presidential steering group to improve management and try to cut bureaucracy, but executives still complain about the lack of tax and labor reforms. President Dilma Rousseff has pledged to cut the tax burden, but structural reforms are not on the agenda.

Rogerio Menezes, CFO of Akzo Nobel Pulp & Paper, is very critical of what he calls “the tax monster”. He says there already have been more than 300,000 changes in the tax legislation, which results in high compliance costs.  This is a drag on Brazil’s competitiveness as a whole.  At present, each of Brasil’s 26 states and the Federal District of Brasilia has its own tax legislation and is able to tax the so-called ICMS (a sort of sales tax on goods and services) at different rates.

“The cost of doing business in Brazil continues to climb, as Brazil has failed to address the principal elements of the ‘custo Brasil,’ such as poor infrastructure, an onerous regulatory burden, heavy taxation and non-compensation labor costs,” says Clinton Carter, head of research for Latin America at Frontier Strategy Group (FSG), a U.S. business advisory firm. “Add to this a scarcity of skilled labor that is pushing salaries through the roof, and the result is a ‘custo Brasil’ that is climbing.”

The bottom line for foreign investors is that “Brazilian business units are less profitable than those in other Latin American countries,” says Ryan Brier, FSG’s Associate Practice Leader for Latin America.

According to an FSG survey , “net margins in Brazil are 5.1 percent narrower, on average, than in the rest of Latin America, largely due to taxes.” Whereas the average corporate tax paid amounted to 48 percent of profits in Latin America, the figure reached 69 percent in Brazil, FSG says. Fast-moving consumer-goods companies are much more heavily taxed than those operating in other sectors, it says.

TIM cites a survey from the GSM Association in 50 developing countries, and Brazil shows up as the country with the third-largest tax burden in the telecommunications industry, behind Turkey and Uganda. But the company says it has been negotiating with the Brazilian authorities to improve the situation.

“TIM has been reviewing with the government what kind of partnerships may lower the tax burden on the telecommunications sector. There is currently some ICMS tax exemption for broadband services in the states of Para, São Paulo and in the Federal district (Brasilia) through the Popular Internet Program,” TIM told Latin Trade.

The maximum price that the company can charge for its services is 30 reais ($17) per month, it says.

FSG says Foxconn is an example of best practice in Brazil. “The Taiwan-based company saw a significant opportunity to serve the Brazil market but was unable to be competitive without significant tax breaks. It managed to leverage its government relations function and the credible promise of US $12 billion in manufacturing investments (near São Paulo) to secure tax exemptions that represent a 40 percent reduction in costs.”

Transport bottlenecks

Logistics costs also are high for domestic companies. Francisco Pontes de Aguiar, the owner of the Amazon Green cosmetics company, says the cost to ship a container from Manaus to the consumer market in São Paulo is three times greater than to import a container from China to Brazil.  “Beyond the ‘custo Brasil,’ we have to deal with the ‘custo Amazonia,’ ” he says.   All companies still have to deal with some inconsistencies: taxes on domestic cabotage (river or coastal shipping) are higher than for international cabotage.

Yet, FDI has continued to pour into Brazil. In 2011, a record was set: $65 billion – and they were not all commodity-related inflows. “With developed markets stagnant, growth opportunities in Brazil become even more appealing despite the challenges. That’s why, from 2009 through 2011, Brazil rose to third from 14th FDI receptor in the world,” says Ricardo Amorim, president of the Ricam consultancy.

Nissan was hard hit by the end the car free-trade agreement with Mexico and the imposition of quotas last March. But instead of protesting, its Brazilian-born CEO Carlos Ghosn says, it will now speed up plans to build its second car plant in Brazil, near Rio de Janeiro. Last year, Nissan had the fastest sales growth in the Brazilian market, partly because of cheap imports from Mexico.  Chinese car manufacturers also say they intend to set up plants in Brazil to avoid paying the new rate of 30 percent of the IPI industrial tax.

Amorim, who used to be an emerging-market strategist at West LB, says: “Costs are rising and margins are getting thinner, but they are still higher than in most other markets, and sales volume is growing, partially compensating that. Some companies that are able to do so are offshoring part of their production. The key point is that Brazil’s importance as a consumption market is growing, while its importance as a prodution market is falling. Still, 10 years ago, Brazil’s industrial production was the 10th-largest in the world. In 2009, it was seventh; in 2010, sixth; and in 2011, fifth.”

The strength of Brazil’s large domestic market has indeed become one its strongest defenses against the global crisis. But doing business in there is definitely not for the faint-hearted. And outsiders will have to continue to pay a high price to be able to join the great Brazilian party.

“Companies have to be there and deal with the consequences – or not be there at all,” Clinton Carter says.