In the early 2000s, Brazil became the darling of corporate investment. It boasted rapid economic growth, abundant natural resources, and a large (and increasingly wealthy) market of 200 million consumers. The government’s pro-growth policies and abundant spending only increased corporate interest and multinational expansion plans. By 2007, Brazil had reclaimed its position as the number-one destination of foreign investment in the region from Mexico, according to CEPAL, one of the five regional commissions of the UN; Brazil also represented 30–40% of a typical multinational’s Latin America portfolio, according to our internal client polling. Few major economies have been so critical to global companies’ top-line—and then stumbled just as abruptly.
By 2011, it had become apparent that Brazil’s recent prosperity depended too much on China’s appetite for commodities and on the Brazilian government’s ability to fuel consumer spending through direct transfers and credit expansion. But because of economic deceleration in China and the
fall in iron-ore and other commodity prices, growth began to slow. Now the business environment is downright gloomy—the economy is in recession, the country just lost its hard-won Standard & Poor’s investment-grade status; its currency, the real, has depreciated to 12-year lows; inflation is nearing 10%; and talk of presidential impeachment has spread virally across mainstream media.
A recent survey of 22 Latin America-focused executives conducted by my firm, Frontier Strategy Group, found that, on average, corporate sales performance in Brazil declined by 6% in USD between 2014 and 2015—and the near-term future does not look any brighter. We are forecasting the Brazilian economy to recover only by mid-2017, with GDP growing at an average of a mere 1.0% through 2020, as investment and consumption struggle to recover amid constraints: historically low confidence levels, the government’s austerity measures, more stringent access to credit, high inflation, and corruption scandals. For example, scandal has severely limited the investment capacity of state-oil company Petrobras and many of the most important construction companies in the country that were also involved in its kickback scheme.
Executives cannot be successful using yesterday’s approach to the Brazilian market, which focused on tapping into the unmet needs of a growing middle class, burgeoning business community, and an ever-growing public sector. With demand from these three groups retrenching as a consequence of economic recession, companies will need to adopt a new Brazil playbook in order to maintain sales growth and profitability.
There are two key strategies that multinational executives operating in Brazil should consider. Each requires leaders to pay particular attention to nuances related to the Brazilian market. First, they should reassess their value proposition for key customer segments to adjust for the country’s economic recession. Second, corporations should take advantage of the unprecedented currency depreciation and localize their business operations.
Strategy 1: Adapt Your Value Proposition
With economic recession, price sensitivity is bound to increase in Brazil—for customers, other businesses, and the government. Proactive companies should revisit their customer segments, making changes to account for shifts in purchasing power and buying behavior. There are many companies that are already tweaking their value proposition to adapt to the needs of more cost-conscious customers through changes in pricing, product formulation, package size, and associated services—companies such as Danone, Nestlé, Neugebauer, and Bela Vista have revamped their product portfolios to introduce individual packages and mini versions, increasing their affordability by consumers and helping these companies protect margins.
This level of responsiveness requires a change in mindset for local marketing teams, especially among junior team members who do not remember the years of economic recession and hyperinflation of the eighties and early nineties. As one consumer goods executive told us, “I’m really struggling to convince junior executives that investing in premiumization of our brands is not the right strategy anymore. We need to start thinking differently, and we need to do it fast if we want to maintain the same level of growth that we saw during the last decade.”
At a recent client event we hosted in São Paulo we asked executives whether they were planning to make significant changes to their value proposition through 2020; 44% of them said “yes” while 28% said that they were in the process of assessing potential changes. Interestingly enough, 47% of respondents that are planning to adjust their value proposition will focus primarily on enhancing value-added services over improving their positioning (21%), product (21%), or pricing (11%).
Value-added services such as product installation, maintenance, and repair, or technical assistance in the case of industrial and IT companies, allow companies to maintain prices and protect their margins. And because multinationals pay for these services in local currency, the steep depreciation of the real has made this strategy especially attractive for multinationals as they report both revenues and costs in US dollars.
Strategy 2: Localize Your Business
Expanding local services is one way in which multinationals can benefit from currency depreciation to protect, and even increase, their market share in Brazil—but it is not the only one. Increasing local production capacity, finding local suppliers, and conducting strategic acquisitions should also be top-of-mind for business executives in the country, especially because the real is likely to continue to depreciate through 2018 on the back of rising interest rates and stronger growth in the U.S.
In the case of strategic acquisitions, currency depreciation tells only half of the story. The economic slowdown has caused company valuations to fall dramatically from earlier highs. In 2011, when the number of M&A deals reached its peak in Brazil, the average price of publicly traded companies was 9.7 times their earnings before interest, tax, depreciation and amortization (EBITDA). By 2014, target price to EBITDA ratios had already fallen to 6.9 times; and during the first half of 2015, valuations have continued to fall, to 4.4 times EBITDA.
However, companies hoping to pursue strategic acquisitions should be aware of intrinsic challenges related to M&A transactions in Brazil. An acquisition can fail for many of the same reasons as other cross-border transactions, such as failure to retain key personnel and poorly designed post-merger integration plans. But companies should also account for unexpected expenses related to tax, labor, and environmental pending litigations, as we have found that multinationals are likely to attract more attention from local regulators and tax authorities.
Additionally, localizing a business in Brazil is admittedly no easy task. In the case of local manufacturing, multinational executives have long expressed frustration directed at the Custo Brasil, the term used to describe the high cost of doing business locally. Even today, production costs have still risen despite economic deceleration, with labor costs outpacing productivity gains and industrial electricity prices rising by more than 50% in 2015 alone. Many of the components that go into finished goods may also not be available for local sourcing in some high-tech industries, which means that many multinationals will still need to import a large share of their inputs.
There is no easy way to win in the current Brazilian operating environment, but the risks of not attempting to adjust business strategy—namely, losing market share to local players and more proactive multinational firms as competition heats up—far outweigh the costs of any missteps that might occur. Companies that choose to adapt their value proposition will not only be defending current sales volumes but also planting the seed for future growth, as customers will become more engaged with their brands. Localization on the other hand, is becoming more of a necessity to stay profitable in an environment of ongoing currency depreciation that will continue to put pressure on import costs.
Brazil is a completely different market today than it was when most multinational companies first entered it over the last two decades. Implementing proactive strategies, like adapting your value proposition and localizing your business, enable companies to take advantage of new market dynamics and capitalize on new sources of growth and profitability. It’s time for multinationals to adopt a new playbook for competing in Brazil; the same strategies that led to yesterday’s success will guarantee tomorrow’s failure.