Brazil RETAIL COUNTRY REPORT March 2016
David Marcotte Senior VP Market Insights Américas WPP – Kantar Retail
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Contents
Introduction: Brazil Struggles to Get Back to Growth ...... 3 A Fragmented Country Ranging from Modern to Emerging ...... 3 Shifting Demographics ...... 4 A Diverse Retail Environment Dominated by Multinationals ...... 5 The Major Brazilian Chains ...... 6 A Range of Channels and Formats ...... 6 Shopping Malls and Specialty Growth ...... 7 Private Equity Becomes a Factor ...... 8 Franchising as a Solution ...... 8 The Activist Government and Distortions ...... 9 Petrobras and the Culture of Corruption ...... 10 The Success of Cash Transfers ...... 10 Tariffs and Restrictions Continue to Change ...... 11 Protected and Open Industries ...... 12 Infrastructure Improvements ...... 13 Retail Regulation: Pricing, Employment, and Credit ...... 14 VAT and Transparency ...... 15 Pricing Transparency ...... 16 The Labor Markets: Expensive Employees, Cheap Contractors ...... 16 The Move from Retail to Consumer Credit ...... 17 Looking Outward to 2020...... 18 Population Changes ...... 18 The Role of Government ...... 19 Channel Development ...... 19 2020 Themes ...... 20 Managing the New Multichannel ...... 20 Conclusion ...... 21
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Introduction: Brazil Struggles to Get Back to Growth
“Brazil is the country of the future ... and always will be,” observed Charles de Gaulle in the 1960s, making light of a perennial frustration with Brazil’s struggles to find steady growth. A country blessed with water, fertile soils, minerals, products of the jungle, and open pastures — not to mention geographic size, location, and population — should have a bright future. However, historically, a number of factors, from governing to global markets, have frustrated Brazil’s development. For Brazil, the future has always proved elusive, at least until the last decade.
Starting with the hard fiscal prudence of the Cardoso presidency from 1995–2003 and followed by the gradual expansion of support to the poor along with a more pro-business attitude by the da Silva (“Lulu”) period that ended in 2011, the country seemed to have finally found a foundation for growth. During the 2014 World Cup when Brazil was to show its new progressive self, more than one commentator declared, “The future is now.” But the sudden slowdown in the global commodity markets in 2008 greatly reduced exports and a drought in 2013 and 2014 reduced key hydroelectric production, stalling the overall economy. And a small scandal exploded to epic proportions that struck the government and business community across its leadership. Retailers and shoppers alike felt the effects, with the softening of the currency adding to import costs. The result? Consumer confidence lagged in 2015 and has almost collapsed with respect to that elusive future and faith in the government’s ability to change and move the country forward.
Retailing in Brazil has always been a challenge given the country’s wide variety of economic regions, changes in currency and banking, complex credit arrangements, and difficult supply chains. But with the overall improvements within the country, retailing has emerged based on predictable product and services, with shoppers who have the means of buying in a mostly orthodox manner leaning more toward commercial credit. The same improvements have touched the informal retail sector as well. In formal retail, the competition is intense. However, a distinctly Brazilian retail format, the “atacado,” resides in between.
A Fragmented Country Ranging from Modern to Emerging
Brazil has a long tradition of fragmentation due to geographic barriers along with settlement patterns from Europe, Africa, and Asia in the 17th century through to the present day. The temperate South is generally modern in its approach to shopping and retailing with a range of retailers that would fit into almost any other developed country. Save for some cities, the tropical North is closer to emerging markets in shopper and retailer behaviours. The central coast and inland areas fall in between. The large cities of Rio de Janeiro and Brasilia form an axis of development, with South being more advanced than North of the imaginary line. The interior has advanced rapidly with the expansion of agricultural techniques that have produced larger yields and overall production of grains and animals generally for export to Asia. Accordingly, urban areas there tend to be weighted toward developed market retail models.
Brazil and retail will be decidedly different in 2020 as an already-dynamic eCommerce market grows with an online population. Infrastructure that will further enable the shopper and retailer is well along in planning and in many cases has already begun. Shopping centers and malls continue to be
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built and opened with international retail chains at every economic level attracted to the country’s 200 million-plus shoppers. The political dynamic at the federal and state levels has already changed more in the last year than in the last decade — promising a change in the control models of public commodities ownership and possibly a reduction in large-scale corruption. The year 2020 promises to be a real focus of current events coming together into a new retail reality.
Shifting Demographics
Brazil is a large country made up of the former Portuguese colonies in South America with a long history of contradictions. Centralized and bureaucratic control-and-command structures balance against myriad local traditions of self-management and independence. People started arriving from Africa as slaves and then as freeholders. Later immigrants to Brazil came from Europe, the Middle East, then Asia. Now, people are arriving again from Africa, though often as not, people of Portuguese origin. Intermarriage has blurred many of these lines, yet many people still have strong ties to their countries of origin. Estimates of ethnicities in 2010 (note these are self-declared) are:
White/European: 47.7% Mulatto (mixed white and black): 43.1% Black: 7.6% Asian: 1.1% Indigenous: 0.4%
Catholicism is the dominant religion at 66% with a rapidly growing Evangelical Christian cohort at 23%, alongside a range of other religions including Islam, Judaism, and Buddhism. In parallel are a number of religious beliefs in practices from the West of Africa. Geographically, Brazil has a full range of climates, soils, ecosystems, and terrains. And despite the variety of the country, almost the entire population speaks Brazilian Portuguese. The population is predictably urban and suburban at 85% and concentrated on the coastal regions, as shown the figure below.
Figure 1. Maps of Brazil’s Major Cities and Population Density
Source: CIA World Fact Book, 2014
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Population growth has slowed considerably in recent years since emigration is now equal to or (as of 2011) less than immigration. The fertility rate has dropped to 1.79, which is well below what is considered the replacement level of 2.1 children per fertile woman. At the same time, the average age has increased, which has generated a population pyramid similar to that of other developed countries. The impact to retail, however, is generally positive because a larger percentage of the population through 2020 will be in the prime working and earning age range.
Figure 2. Population Growth Rates and Population Pyramid
Source: Instituto Brasileiro de Geografia e Estatística, 2015
A Diverse Retail Environment Dominated by Multinationals
Brazil’s retail landscape has been transformed by consolidation by some of the largest international retailers. Each has a broad representation in channels and formats, but none has 100% penetration into all the states.
France’s Casino is the largest player by far with full or part ownership to the largest hypermart, grocery, consumer electronics, home goods, “atacado” (a type of cash & carry that originated in Brazil), and online retailing companies. The company has grown rapidly through mergers and acquisitions, most recently taking full control of the Pão de Açúcar Group and control of the very large merged consumer electronics group Via Varejo (made up of Casas Bahia and Ponto Frio). In turn, this group created the CNova online group as a joint venture of Casino global and Pão de Açúcar.
Carrefour follows at roughly half Casino’s volume. In general, it is branded as it is elsewhere internationally, the exceptions being its Atacado banner (the original of which generated the format name) and its fast-growing Express formats.
Walmart is third in volume, but operates a wider range of banners and formats across the country. In the North, it is primarily the Bompreco hypermart and grocery chain. In the center, it goes under the Walmart Supercenter, Sam’s Club, and the smaller-format Toto Dia brands. In the South, it has a collection of banners. It also operates a fast-growing online operation. At the beginning of 2016 it closed 60 stores across all banners, roughly 10% of its total units.
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Cencosud is the other major multinational that owns five hypermart and supermarket chains in the center and North of the country. The largest banners are GBarbosa, Bretas, and Prezunic.
Other multinationals include Makro, which is considered the third largest cash & carry; CVS from the U.S., which owns a small pharmacy chain in Sao Paulo; and the Mexican-based consumer electronics reseller Elektra. The Chilean retail group Falabella also operates the two home improvements chains of Sodimac and Construdecor.
The Major Brazilian Chains
Most formal retail in Brazil is associated with multinationals, but a number of large consumer electronics and home goods retailers exist:
Magazine Luiza is a consumer electronics reseller that also handles home goods and furniture. It has coverage across much of the country with a focus on lower-income and middle-class shoppers. It also operates a large and diverse website.
Máquina de Vendas is slightly larger and also serves much the same market of consumer electronics. Formed from the 2010 merger of Ricardo Eletro in Belo Horizonte and Insunuante in Salvador, it operates in all states.
Raia Drogasil is a drug store chain that resulted from the 2011 merger of Drogasil and Droga Raia and the buyout of the Panda drug chain in 2012. It has more than 1,100 stores concentrated in the South and interior. Other smaller chains include Pague Menos in the Northeast and Pharma Brasil that operates banners in the Bahia state and surrounding area.
Lojas Americanas is a chain of small department and variety stores throughout the country. It is owned by the powerful 3G Capital private-equity company, which is made up of investors Jorge Paulo Lemann, Marcel Herrmann Telles, and Carlos Alberto Sicupira. Lojas Americanas also owns a controlling share of the eCommerce group B2W, which is made up of the banners Submarino, Shoptime, and Americanas.com.
A Range of Channels and Formats
Given the diversity of the country’s people and their needs, retailers operate in a variety of ways to reach shoppers.
Big stores, such as hypermarkets and superstores: As in other markets as the overall retail landscape matures, growth of these formats is slowing. This is the case in the southern regions, where these formats still do well in drawing trade, but new store construction is a fraction of what it was in prior years. The less-developed parts of the country are still quite strong for hypermarts, with Bompreco in the Northeast; GBarbosa in the Salvatore coastal region; and Walmart, Carrefour, and Casino’s Extra.
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Atacado: This Brazilian-style cash & carry format has been spreading to other parts of Latin America and Southern Europe. These stores are usually quite large (some are up to 20,000 square meters) with interiors featuring very tall warehousing with pallets stored over regular shelving. Product is sold either as eaches or by the case; both prices are printed under the products being sold. The perimeter features perishables, such as those found in large supermarkets. Shoppers are typically small shopkeepers, restaurants, institutions, street vendors, and often lower-income households. The original “Atacado” was bought by Carrefour and rapidly expanded across the country. Casino (Assai) and Walmart (Maxxi) followed by opening their own banners, though overall growth has stopped during the economic crisis of 2016.
Small stores: Neighborhood grocery, express supermarkets, and chain drug stores have been expanding and changing in the last decade with more focus on a mix of upscale lifestyle and basic product, depending on location. These follow demographics with some clearly being for high-end shoppers, but the majority are intended for lower-income neighborhoods. Chain drug is now in larger locations and has become far better merchandised than in the past. Most have expanded into health and beauty with brand- centric displays. Some of these stores now carry food and beverages.
Combination gas, convenience, and drug: As more people own cars (the current one-in-four ownership level is expected to increase to one in three by 2020), the need for petrol stations has increased. Most stations now have a small convenience store of 100 square meters, but increasingly a drug store of the same size is in the same building. In the South, most gas stations under construction have this combination format. The chains involved are usually franchised operations. Convenience versions of the small grocers continue to evolve, with Casino doing so with Mini Mercado Extra.
Online retailing: eCommerce started early in Brazil and continues to grow steadily. The market leaders of the banners owned by B2W and CNova dominate, with multiformat doing reasonably well from the major retailers. More recently, health and beauty has been growing rapidly as an online product. Alibaba is clearly in the market and a factor, but it is difficult to pinpoint the share it represents due to its business model. Oddly, it benefits from the difficulties of fulfillment in Brazil since the longer shopping times from China are not greatly at odds with local supplier delivery timelines.
Shopping Malls and Specialty Growth
Shopping mall growth is projected at 7%, slowing from 7.6% in prior years. Construction continues in urban and suburban locations, with destination and lifestyle malls emerging as the new preferred format. Regardless of income, Brazilians have been flocking to malls not only for shopping, but also for food, entertainment, and basic services. Most malls combine parking under or within the mall, which is often a draw in itself in areas that lack secure parking spots. Specialty store growth has followed, though at a slower rate since, in many cases, it requires retailers to move from older locations to new ones.
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Generally, malls are multistory structures and lack an anchor store typically found in older malls elsewhere. Food is a major trip driver because almost all major chains and many independents are now located not just in food courts, but often throughout the building. In upscale malls there is also a service element which is provided by the mall operator that includes home delivery.
Private Equity Becomes a Factor
Private equity has become a factor in Latin American retailing, with Interbank in Peru and Southern Cross in Chile showing how the model can work to create a portfolio of companies with retailers in the mix.
In Brazil, global leaders in this area are led by 3G Capital, which partnered with Berkshire Hathaway in the U.S. to buy the international brands of Heinz and Kraft in recent years. Within Brazil, it controls the AmBev group of beer and beverage producers around the world, which it later merged with two other global companies into Anheuser-Busch InBev. Within retail, it bought and invested more than USD1 billion in Lojas Americanas and the B2W websites of Submarino, Shoptime, and Ingresso, further accelerating eCommerce growth.
Other smaller groups are worth noting since they are all active in multiple industries, including retail. Gávea Investimentos is a good example, which purchased control of the clothing retailer Camisaria Colombo in 2010 and recently sold its interest back to the original owners. Kaszek Equity and Tiger Investments in the U.S. have recently provided funding to BelezaNaWeb.com, which is the largest dedicated eCommerce site in Brazil. The Squadra private-equity firm recently acquired the Rede Imaginarium franchise of home products. W7 Brazil Capital recently bought and drove the merger of two baby-oriented eCommerce sites, BebeStore and Baby.
Franchising as a Solution
Brazil is the fifth-largest market for franchising in the world due in no small part to the challenges of establishing a business as an outside company and the country’s labor laws (detailed later in this report). The failure rate for new businesses is about 80% within the first year, and the average amount of time needed to close and clear all obligations can take up to four years. Franchises provide a middle way, with the individual taking on the tax and labor issues and the franchise provider lowering the before-and-after costs, so that 85% of all franchises stay open longer than a year. In 2014, franchises employed an estimated 900,000 working-age Brazilians.
As of 2014, the largest retail-oriented franchise companies in Brazil included:
O Boticário, which is Brazil’s leading company in the cosmetics sector, with annual revenue of BRL7.6 billion. As of 2014, O Boticário had 3,650 stores in more than 17 states.
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Ortobom specializes in the production and sale of mattresses. Founded in 1975, the company now owns 1,860 stores in Brazil. In 2010, it opened its first store abroad, in Bolivia. In 2013, it opened stores in Uruguay and Paraguay.
McDonald’s opened its first restaurant in Brazil in 1979. Since then, it has opened more than 800 restaurants, more than 700 shopping-mall kiosks, and nearly 100 McCafés.
Cacau Show is a Brazilian food company that specializes in chocolate production. Founded in 1988, Cacau Show is the largest network of fine chocolate in the world and has more than 1,600 stores in Brazil.
Subway opened its first restaurant in Brazil in 1993, and as of September 2014, had more than 1,600 restaurants in the country. Brazil is the third most important market for Subway in the world, trailing only the U.S. and Canada.
AMPM Mini Market are convenience stores that operate exclusively in Ipiranga gas stations in Brazil. As of September 2014, more than 1,500 AMPM Mini Market stores were operating in the country.
Jet Oil is a network of stores, founded in 1994, specializing in oil changes and other automotive services. Like AMPM Mini Markets, Jet Oil operates exclusively in Ipiranga gas stations.
Bob’s is a Brazilian fast-food restaurant that first opened in Brazil in 1952. It is the third- largest fast-food network in Brazil, behind only McDonald’s and Subway.
BR Mania is a network of 850 convenience stores operating exclusively in Petrobras gas stations. The first store opened in 1994.
Dia is a Spanish supermarket network present in Brazil since 2001. With more than 700 supermarkets, Dia employs more than 6,000 people.
The Activist Government and Distortions
Brazil’s governments have long been deeply engaged in activities that directly impact retail, including import tariffs and restrictions, infrastructure underfunding, labor laws, income distribution, business regulation, and taxation. These activities are not limited to the federal level; individual states and larger cities also have their own legal structures that impact retailers and manufacturers that partner with retailers. In light of the ongoing Petrobras scandal and its revelations, corruption must be mentioned as well since it impacts retailers and shoppers. And it now appears to creating more visibility into a range of additional areas of weakness. Overall the impact may be a ‘lost decade’ for Brazil.
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Petrobras, the Culture of Corruption and Political Paralysis
In 2007, national petroleum company Petrobras discovered deep-water oil sites off the northeast coast of Brazil. Acting on that information, it auctioned off partial ownership to multinational oil companies and began building massive refineries and port facilities on the mainland. By 2013, it was clear that massive amounts of funds — the current working estimate of USD3 billion is considered low — had been diverted from these projects to Petrobras management, the construction firms, and government officials. More than 60 legislators are currently under indictment.
Dilma Rousseff, the current president is not direcly implicated but was in responsible for Petrobas prior to taking office. Recent evidence of her 2015 campaign accepted some of these funds has started impeachment procedures. However most of the individuals including the Vice President involved in the process are also under indicatement. The popular prior president, Luiz Inácio Lula da Silva, is also under investigation for funds used to purchase luxury properties. Unrelated to the scandal the presisdent prior to da Silva, Fernando Henrique Cardoso, who is seen as a source of stability in Brazil was accused of using a state company to pay support secretly to a fomer mistress and her child. Overall, the leadership of the country as a whole is addint more negatives to the scandal, not leading a way out.
What is causing more of an impact to Braizl at at levels is the overall complexity and breadth of the scandal. The government has frozen funding to all firms and government groups included in the project since it is unclear how involved each group was to the scandal. This has resulted in large- scale unemployment in the northeast areas surrounding the refineries and an almost complete stop to infrastructure projects by the large construction firms involved. Two of the construction firms under indictment were also heavily involved with building World Cup stadiums, another unfolding emotional scandal as some of these new structures have collasped. Note that the upcoming Olympics centered in the Rio de Janeiro appears to have sidestepped most of this fall out due to the state-centrics and foreign investment supporting construction.
Combined with the sudden fall in international oil prices, this situation is costing the country an estimated USD30 billion in reduced GDP per year. Further investigations revealed that the reservoir system to be built over the last 20 years to control the flow of water to hydroelectric dams was also part of this culture of corruption. In a country where 90% of its power comes from these dams, the drought of 2014 and 2015 had a major impact on industry and services due to electrical cutbacks.
Separate from the scandal but important to place in context is the emergence of the Zika virus which struck Brazil first and harder then elsewhere with birth defects. If the business and political setting was in better shape it still would be a major concern. Within these factors of weakness it is having a higher impact on the consumer than would be expected.
In light of the above and how it touches most of the country negatively, it is not surprising that consumer confidence in general — and in Brazilian institutions in particular — have weakened. In the past few years, this lack of confidence has slowed consumer spending at most retailers.
The Success of Cash Transfers
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Traditionally, anti-proverty programs have addressed food shortages, education, and health issues. However, Mexico in the 1990s launched an alternative called Oportunidades. This program differed considerably from traditional anti-poverty programs in that it provided a straight cash payment (later an electonic benefit transfer, or EBT) to very poor families who participated in the program. Originally set up as paying families to send their children to school regularly, thus improving their potential to rise out of poverty, the program broadened quickly to include mandatory participation in family health, financial education, and job skill classes.
The success of the Mexico program attracted the attention of various Brazilian states. Under the Cardoso presidency in 2003, it was made a full federal program called Bolsa Familia. It was further expanded under the Lulu administration from 2006 onward to cover 25% of the population, directly impacting 14 million Brazilians. The World Bank regards it as one of the most successful programs for moving the poor into the middle class. Since the program began in 2003, approximately 30% of the country’s population moved from the lowest classes to the middle class.
Payment is made monthly via an EBT card issued by Caixa Econômica Federal, a government-owned savings bank. The funds can be used in shops and stores or withdrawn as cash at one of 15,000 Caixa locations. Transparency standards are high; each step of funding, process, and payment is documented on a public website. Normally, the female head of household handles the funds, which has enabled changes in family dynamics. The regular payments also provide a basis for changes in shopping because families have more predictable funds as well as access to credit from retailers.
The benefits to retail were unexpected, but welcome. Very low-income shoppers had historically spent the money they earned that day. Now, with predictable income, they started to plan purchases more carefully and shopped for price and promotion, which made formal retailing more competitive. Having bank accounts and known income also meant that formal retail and commercial credit became more available to far lower-income shoppers than in the past, which increased spending. What’s more, these programs “trained” shoppers in middle-class behaviors and expectations, which had implications for store formats. Before, stores were either for high- or low- income shoppers. But with this demographic shift, retailers could start merchandising part of the store for the upper middle class, which is aspirational for most shoppers, and the rest of the store for lower-income shoppers.
This created a shift in demographic expectations with regard to store formats being either for high- or low-income shoppers to a more defined upper-middle-class approach to merchandising.
Tariffs and Restrictions Continue to Change
Importing into Brazil has its challenges, not the least of which is the changing rates applied to product and licensing, point of origin, and Mercusor Trade Zone items. Imports are subject to a number of taxes and fees in Brazil, which are usually paid during the customs clearance process. Three taxes account for the bulk of import costs: the Import Duty (II), the Industrialized Product tax (IPI), and the Merchandise and Service Circulation tax (ICMS). In addition to these taxes, several smaller taxes and fees apply. Most taxes are calculated on a cumulative basis.
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Brazil and its Southern Common Market (Mercosul) partners, Argentina, Paraguay, and Uruguay, implemented the Mercosur Common External Tariff (CET) on Jan. 1, 1995. Each country maintains a separate exceptions list of items for tariffs, which changes annually and is negotiated between each country separately from the group as a whole.
Aside from import licensing and administrative costs, Mercosul tariffs have averaged 13% for the last five years versus 32% for the rest of the world. Note that the average Mercosul rate in 2014 was 20%, reflecting overall upward changes with Argentina. The table below summarizes that range for non-Mercosur product (II and IPI only):
Figure 3. A Sample of Current Brazilian Import Tariff Levels
Tariff from Product Type Declared Value Yarns 18% Fabric 26% Apparel 35% Home Furnishings 35% Carpet 35% Footwear 35% PCs/Laptops 55% Cars 55% Used Product Prohibited Source: Ministério do Desenvolvimento, Indústria e Comércio Exterior website
The ICMS can mean additional tariff costs because it is applicable to product moving between states within Brazil. Varying from 5% to 20%, these rates are often item specific and do not follow the general logic of the federal import tariffs. Some states apply this tax at the same rates to changes of product ownership within the state boundaries.
Two additional tariffs to note are:
A 25% long-distance maritime tax on foreign agricultural imports, particualrly from the U.S. A personal import tax on product ordered from outside the country (such as from Alibaba or Amazon U.S.), which is normally 60% of the value paid by the importer
Used products that would be available from MercadoLibra or eBay are technically prohibited from import.
Bidding on government contracts by non-Brazilian companies is further complicated by the 2011 Plano Brasil Maior. This set of laws established the qualifications of bids to acceptable price differences; for example, Brazilian aviation companies can bid up to 25% more than foreign companies and be considered on par. Given the dimensions of the government at federal, state, and municipal levels, this acts as an additional external tariff.
Protected and Open Industries
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Obviously, these tariffs are intended to isolate industry within Brazil, so most multinational manufacturers have set up in-country capacity. It also means that products manufactured in Brazil are rarely exported, given all the additional costs built into components and materials. Product research and development investment — not to mention productivity improvements — are also quite low compared with international standards.
The exception is agriculture, which is the major Brazil success story. Many crops have the largest percentage of overall international trade. Sugar, coffee, orange juice, and beef production are all first in international league tables, with soybeans and corn second and third, respectively. This is not accidental. The country made major investments going back to the late 1950s in R&D of new seed and animal stock. It also has some of the best integrated infrastructure for moving product to ports. The recent difficulty for this industry is it has grown over-dependent on trade with China. As in other countries Brazil has been impacted by the drop in Chinese demand.
Infrastructure Improvements
Improvements to infrastructure continue, but unevenly across the country. As detailed in the section on the Petrobras scandal, government investment that would have flowed to infrastructure projects has slowed considerably due to confusion over how funds have been spent in the past. Externally, international markets and investment firms that would normally help underwrite financial products to support investing in Brazil are waiting to see how the scandal unfolds. The end result is that, with the exception of those related to the 2016 Summer Olympics, previously planned projects and improvements are not getting built.
Other infrastructure areas to be aware of include:
Railways: The railroads are particularly problematic in Brazil. Various systems are under the control of both private and public operators with little coordination or defined investment. Aside from the agricultural and extraction industries (until recently, iron ore was 75% of volume), transporting goods or materials in a linear and proprietary fashion from the interior to a few ports is complicated by the use of multiple rail gauges (broad, narrow, and standard gauge). The multiple gauges make it difficult to build or purchase equipment on the scale needed. At the moment, there are no clear plans to improve the rail system, thus putting more burden on the roads.
Surface roads: Roads are the primary means of transporting passengers and freight throughout Brazil. The Brazilian highway system is one of the largest in the world, but due to geographic features and lack of integrated planning, it also bottlenecks in the major cities. Truck traffic alone has caused major traffic jams in Sao Paulo and Rio de Janeiro that have lasted days. With car ownership now up to one passenger car for every four Brazilians, the road network is under stress. In the last decade, major investments have been made to improve matters, especially to connect rural areas to urban centers via private highways. The road system will continue to be a major issue to 2020, since alternative transportation and road construction is unlikely to keep up with industrial and population demands.
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Air transportation: Flying is an area of constant improvement in Brazil. Looking ahead to 2020, plans include newer facilities, planes, and supporting air traffic control. Brazil has more than 300 airports, 21 of which are defined as international commercial ports. Aside from the air transport improvements made related to the 2014 World Cup and the 2016 Summer Olympics, passenger air travel is healthier than in the past. The country’s air cargo capability is also profitable and efficient. Given the physical demands of the country, along with the limitations of road and rail travel, air travel is critical looking to 2020.
Waterways: Water transport has always been important to Brazil. Bulk shipping from the Amazon ports and in the far southern part of the country has been modernized to handle commodities; however, containerization is still relatively limited. The Port of Santos handles more than one-third of all container traffic and close to 60% of all international imports by container. Use of internal waterways is underutilized due to lack of investment. Ocean port improvements are currently complicated by the ongoing Petrobras scandal. The government has clear plans to improve ports for all traffic by 2020.
Power generation: By law, power generation in Brazil is stated owned. Power is highly dependent on hydroelectric plants, which generate almost 90% of the country’s power. This has generally meant dependable power to all industries and regions. However, regional droughts in the center of Latin America have created unpredictable water shortages that impact power generation. There is also only limited power brokerage between countries, so it is not possible to make up a shortfall through trade. Most planning is focused on making existing plants and infrastructure more efficient and dependable. Note that the country has no standard voltage for appliances and home wiring; voltages range from 117v to 220v. In practical terms, almost all electrical devices need to be of the dual-voltage variety.
Telecommunications: Well developed and efficient, the telecommunications industry includes landlines, mobile services, television broadcasting, radio broadcasting, and Internet access. Today, more than 50% of Brazilians have Internet access. The telecommunications infrastructure is fairly modern, particularly in the south-central area of Brazil. However, the north and northwest areas are drastically less developed. This is an area in rapid transition as mobile technology and requirements change.
Overall, infrastructure is a pressing concern for Brazil that will require clear five-year planning and funding that has been difficult to find. Any company doing business in Brazil should do a serious assessment and risk mitigation for future planning.
Retail Regulation: Pricing, Employment, and Credit
Since 2004, the retail market in Brazil has grown at twice the rate of GDP, approximately 110% versus 45%, respectively. The government understands the role retailers play in creating modern markets and shoppers across the country. As with other industries, the federal and state governments have many laws and regulations that impact retail operations, so compliance conflicts
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are not unusual. What follows is a basic overview of the realities to operating a retail business in Brazil.
VAT and Transparency
As discussed in the section on tariff costs and fees with interstate movement, there are a range of overlapping and incremental taxes on product and services. All taxes in Brazil are value-added taxes (VATs) and are reflected in the price charged for a product. There are two value-added taxes in Brazil: one is a state sales tax (Imposto sobre Circulação de Mercadorias e Serviços, or ICMS) and the other is a federal excise tax (Imposto sobre Produtos industrializados, or IPI).
A discussion of ICMS is included in the tariffs section; however, it should be noted that this tax is also applied to transport services, such as trucking, communications, and electricity. On average, the tax rate is 15% to 17% of the value of the product at the time the tax is applied, which means on top of the prior taxes and fees already charged. Interstate is charged on top of this total.
IPI excise tax is due, with a few exceptions, on all goods imported to or manufactured in Brazil. This include taxes on inventory, production, and volume of sales. On average, this tax can add up to 50% of the value of a product before it is received by the retailer. These taxes can be higher if the product is sold to a distributor or repackaged.
Additional taxes include those due on supplying goods or services: services tax (Imposto Sobre Serviços, or ISS), social contribution on billing (Contribuição para o Financiamento da Seguridade Social, or COFINS), and contribution to the social integration program (Programa de Integração Social, or PIS). The 17% ISS is a municipal tax on gross billings for services. The COFINS, described as a social contribution, funds social welfare programs. The 7.6% COFINS is charged on gross receipts from supply of goods and services. At 1.65%, the PIS funds the unemployment insurance program.
VAT is normally 19% for products sold at retail. But that rate reflects only ISS, COFINS, and PIS, along with a range of exclusions and reductions established at the state and federal levels. Indirect additional costs imposed on shipping to the retailer are considerably higher.
Impact on Retail
The lack of transparency about taxes is an ongoing social issue, especially due to the general concern about government spending resulting from the Petrobras and other scandals. Since all taxes are part of the final price a shopper pays, there is a lack of knowledge about how much is actually taxed on top of manufacturing or import costs. The obvious impact is high prices for most products for sale at retail, which, in turn, has created a vibrant informal retail trade. Aside from the costs added to the product, accounting for and declaring tax revenue to various government groups is difficult. Many retailers — such as small groceries, independent drug stores, garment resellers, and restaurants — that would normally be considered part of the formal economy often operate outside the system. Chain retailers, especially those in the less-developed center and North of the country, are at a price disadvantage, especially for common household purchases.
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Lack of Transparency
According to 2011 research by the National Industries Federation of São Paulo, about 80% of Brazilians have no idea how much they pay in taxes on their purchases. People generally underestimated the actual amount by more than half. With roughly 50% of government tax revenues derived from consumption taxes, there are regular attempts to provide more transparency to the system. Since these costs impact its competitiveness with the informal retail trade, chain retail is a strong advocate for making them better known. Law 12.741/2012 on Transparency of Local, State and Federal Taxation of 2013 would require that with every legal transaction, individuals acquiring products or services would receive all the information concerning the amount of taxes that determine the final sale price. However, due to complications of the tax code, this information has been difficult to state on the retail sales receipt.
An extreme example of how much taxes distort the market is shown in Apple’s recent iPhone pricing. Though Apple has manufacturing in Brazil, iPhones are mostly imported. Despite the prices shown in the table below, iPhones are selling as rapidly as they become available, regardless of recent price increases and the price differential with the U.S. market.
Figure 4. Pricing of Select Apple iPhones in Brazil and the U.S. Markets
Brazil Pricing U.S. Pricing Device 2014 2015 2015 iPhone 5s, 16GB BRL 2,000 2,500 99 USD 825 938 99 iPhone 6 Plus, 128GB BRL 4,400 4,700 499 USD 1,651 1,783 499 Source: ZDNet Price Survey, March 2015
Pricing Transparency
By law, all retailers over a certain size (which differs by state) are accountable for price accuracy. Part of this requirement comes from the hyperinflation periods prior to 1995, but continues today as a requirement for in-store price scanners. On-shelf pricing must match scanned prices; if they do not, retailers are fined. For most major retailers, this has made installing electronic shelf tags cost- effective since the information derived is from the same source. Online retailers have recently been subject to similar laws that require their online prices to match the prices they charge to shoppers’ credit cards.
The Labor Markets: Expensive Employees, Cheap Contractors
Given the rapid growth of the retail market, there has been a matching demand for labor, including entry level and educated management. This demand has increased labor costs, often faster than the growth in sales. Overall, Brazil is considered an expensive country in which to hire and maintain a workforce, which is a consideration for retailers and suppliers. Retention can be an ongoing problem
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since many workers see individual jobs as career stepping-stones or as a way to gain valuable skills and experience.
Rules governing full-time employees include the following:
Working hours cannot exceed 44 hours per week and overtime is limited to two hours per day. These limits are not as strictly enforced as stated in the Federal Constitution, but can easily be used in “work to rules” actions along with suing an employer. Brazil has the highest rate of employees filing suit against their employers in the Americas. Most service employees are unionized, which increases the complications associated with time committed to work.
Time off for full-time employees is 30 days for every 12 months of work. A dismissed employee is owed the amount that represents that plus an additional 33% as severance.
The 13th Month, which is found elsewhere in Latin America, is equal to one month’s pay split into two annual payments that are normally made in the last two months of the year, so they function as a holiday bonus of sorts. These payments have sparked a number of “Black Friday”-type sales promotions, though not at the same level as Mexico’s “Buen Fin.”
Unemployment insurance, the Fundo de garantia por tempo de service (FGTS), is 20% of the employee’s salary. The employee pays less than half. The rest is paid by the employer, representing an additional employment cost.
Aviso prévio is the formal declaration that both employee and employer give when they are no longer willing to work together. Notification for either termination or quitting is 30 days prior to departure. Upon notice, most companies will pay the 30 days’ salary along with any owed vacation pay rather than wait for the time to elapse.
Pregnancy leave is 120 days, and the employer must hold the employee’s job for up to five months after the birth. Fathers can take up to five days of paid leave after the birth.
Transportation and meals are paid for by the employer. In most cases, this is a flat sum provided either in pay or as an electronic payment card.
The self-employed and contractors can do quite well in Brazil. They are worth more to employers because they are paid only when needed and are not eligible for the benefits available to full-time workers. At the same time, the self-employed can purchase health insurance from the government at a slightly higher cost than those covered by labor laws (and often get better coverage). Highly skilled labor and professionals are more likely than in other countries to be contractors.
The Move from Retail to Consumer Credit
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Brazil has historically had huge swings in internal financial markets, hyperinflation, and external currency fluctuations, which have made retailing dependent on a range of innovative consumer credit solutions.
Stores typically state prices based on payments and terms, not actual prices. Since shoppers saw credit as almost a right, retailers responded with advertising that included the concept of “credit without bureaucracy.” Given the large numbers of workers and families with incomes but no documentation, many retailers, such as Casas Bahia and Magazine Luiza, trained staff to evaluate shoppers on sight without the normal proofs of ability to pay. These high-risk programs required high interest rates, which turned into a major area of profit for retailers.
With the Cardoso Real Plan of 1995, hyperinflation was finally brought under control, now averaging 8% during higher periods. The overall improvements in income and stability in the 1990s and 2000s, which made possible a rise in home and car ownership rates, eased many more lower-middle-class families into banks and credit plans. With inflation relatively calm over the last decade and the banking system secure, more formal consumer credit programs are available now than in the past. Major banks have partnered with a range of credit card firms to provide a number of solutions to Brazilians, which not only increased consumer spending, but also evened out the highs and lows of a cash-based economy. The greater transparency and knowledge of interest rates has eroded the use of retailer credit, and for the most part, most retailers today are co-branded arrangements with commercial banking and credit card companies.
With the economic stress that started in 2010, interest rates have increased. More recently, exchange rates with the U.S. dollar have dropped the value of the Brazilian real almost in half impacting imports and a number of internal contracts written to that currency. Loan defaults have risen slightly, but the number of people backing out of home purchases has become a larger issue. In 2014, more than 20% of prospective homebuyers under contract declined to sign the final ownership papers. People are more aware of their overall exposure to mortgages and car loans. Overall, consumer credit as a percentage of GDP has grown to 50%, which is a manageable level, but will become problematic if the economy contracts further.
To date, the level of consumer credit has not impacted retail credit use, but there is awareness on the part of Casas Bahia, Magazine Luiza, and others, that it should slow in the near future. In this climate, retailers have been moving away from profit-generating credit programs. With most retailer credit programs now co-branded and generating much lower (though predictable) revenues, retailers are placing more emphasis on inventory turns, consumer traffic, and product profitability.
Looking Outward to 2020
Brazil will continue to be challenging for retailers, vendors, manufacturers, and shoppers. But given the country’s size, economic growth, growing middle class, and the strength of the retail sector, there are number of positives looking toward the 2020s:
Population Changes
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Changes in the population are creating a larger group of people in their prime earning years, with that group expected to grow until 2025. As in other countries that have moved past emerging status, the retail sector is growing faster than the overall economy. However, a larger aged and retired group, especially those who took early retirement and government workers drawing pensions, is already starting to put stress on services. Smaller groups of the population (those younger than 15) do not impact 2020, because, based on experience, fewer children often means more spending per child. Retailers have already adjusted their product mix to this group. Unless there is a major rise in immigration, all of these trends should remain predictable.
The Role of Government
The government will continue to be highly centralized and intrusive in all aspects of the economy. However, given the experiences of the past decade, the positives of encouraging more retailer development along with the negatives of government corruption should focus more attention on privatizing more functions. The difficulty for 2016 and 2017 will be re-establishing political leadership capable of driving change.
The well-known complexity and opacity of tax collection has become an election issue that is starting to prompt the government to devise a new way of at least communicating VATs to the shopper. However, beyond a possible unified designation, any simplification of the multitude of taxes and fees should not be expected in the next five years. No changes to import tariffs and regulations should be expected in the near term either, since too many businesses and unions benefit. New taxes recently suggested to correct the government deficits but are unlikely to come into law in 2016. Transparency laws are gradually making an impact on local actions, such as accessing fees and distributing funds to the poor; these laws will have increasing impact by 2020.
Channel Development
Current channel development trends will continue, though there will be a general movement of larger stores getting smaller and small stores getting larger.
Big-box retailing still has room for growth in the interior and Northeast, but generally is slowing. Compact hypermarts are starting to emerge with the big three retail groups, as is eCommerce integration. Smaller formats are the current main growth driver; based on global patterns, expect that trend to continue to 2020. Chain drug is consolidating, and will go through another sequence of that in the near term. It is highly likely that one of the large U.S. drug chains will purchase more chains and fund new growth. Home improvement will grow based on home ownership trends that should correct and continue growing through 2020.
Convenience and petrol, fueled by increasing car ownership and commuting, is an established partnership for growth that will continue within the franchise models already set. By 2020, it is likely that the average square meters of retail space within these stores will double to meet shopper needs.
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Grocery will continue to grow steadily, but with more emphasis on quality merchandising and product assortment in smaller boxes.
The Atacado format may have reached saturation in the coastal areas, but growth should continue inland as the population continues to shift. The smaller versions popular in Peru and Chile with a more general population focus may start emerging.
Clubs are very under-realized in Brazil at moment, given the large middle class. By 2020, expect at least one additional chain in the country.
eCommerce will continue to grow more than 10% annually into 2020, but could grow faster if fulfillment challenges are overcome. A major question here is the role of government in limiting single imports from non-Brazilian sites. Categories sold online are likely to expand. However, given Brazilians’ engagement with fresh food, expect online grocers to lag.
Mall growth will drive the continued expansion of chain specialty in all settings, from dense urban to relatively rural locations. Malls create a closed environment where shoppers can be in a comfortable setting. They also provide retailers with a source for reliable power and infrastructure. Malls will facilitate the growth of such retail channels as apparel, chain drug, restaurants, and consumer electronics.
2020 Themes
Major 2020 themes are likely to reflect those found in emerging and developed markets internationally, including:
Health and wellness, already a dominant theme in chain drug, is also a driver for organics, supplements, and vitamins — all of which are experiencing current growth. The aging population and greater focus on wellness by the middle class will fuel this trend well past 2020 in all parts of the country. Lifestyle and retail as entertainment has already been seen in urban concept stores and malls in the last few years. This trend is spreading rapidly to the suburbs in high-end grocery and in highly engaging merchandising in newer stores. Third-party credit is already popular throughout the southern part of the country. Retail-based credit will rapidly give way to bank credit cards and co-branding.
Managing the New Multichannel
Large-scale mergers and consolidations in most channels are winding down, with most of the smaller survivors already executing a brick-and-mortar plus eCommerce multichannel model. The larger players are now coming to terms with not only launching eCommerce sites, but also with managing them profitably in the context of their other store formats. The placement of assets, including inventory, labor, and IT, is among the decisions to be made that will remake the retail landscape in 2020.
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Conclusion
Kantar Retail fully expects Brazil to be one of the largest and most interesting retail markets in the world, overtaking other countries in consumer sophistication, segmented supermarket positions, and lifestyle store design.
That said, Brazil will lag other markets in some areas as it copes with a complex and intrusive government; an underinvested, underperforming infrastructure; and an economy that is still trying to find a new route to growth.
Suppliers and retailers looking to identify and build best practices should keep an eye on Brazil to learn more about:
Best-in-class shopping design in stores and malls Lifestyle grocery Convenience concepts Growth of eCommerce competition to more channels
Kantar Retail looks forward to watching Brazil develop in the next five years with our clients currently in or just entering the market.
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ABOUT KANTAR RETAIL
Kantar Retail (www.kantarretail.com) is the world’s leading shopper and retail insights and consulting business and is part of the Kantar Group of WPP. The company works with leading branded manufacturers and retailers to help them transform the purchase behavior of consumers, shoppers, and retailers through the use of retail insights, consulting, analytics, and organizational development services. Kantar Retail tracks and forecasts more than 1,200 retailers globally, has purchase data on more than 200 million shoppers, and counts the annual PoweRanking survey (U.S. and China) and Industry Shopper Study among its market-leading reports. Kantar Retail works with more than 400 clients and has 20 offices in 15 markets around the globe.
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