Original article appeared in the Financial Times on February 21, 2012
A friend recently joked over dinner that it is cheaper now to get your shoes shined by a Brazilian in New York than by a Brazilian in São Paulo.
This week, a quick check showed the claim to be true – the price of a shoe shine in central São Paulo was R$10 (about $6) before a tip while one from a Brazilian shoe shiner working the New York office market was $5 including tip.
You might say that serves people right in the first place for getting others to shine their shoes, but that is an argument for another column. The fact is the shoeshine test is just another indicator of the remarkably high cost of business in Brazil.
For managers of multinationals in the booming economy, particularly those arriving fresh off the boat with a spreadsheet full of profit targets copied and pasted from the business plans of their peers in India and China, the country’s high-cost base is the first thing that will hit them. Whether it is that credit-card bill after a night out in Rio de Janeiro or the first hard look at the company wage bill in the office, the new manager will soon have to confront what is called Custo Brasil – the Brazil cost.
This is the conundrum businesses face: Brazil is a high-growth market in terms of opportunities for revenue expansion but it is on average a low-margin market in terms of profitability, particularly for companies in the start-up phase.
The new chief executive will quickly realise that his or her success or failure in Brazil will depend on managing the expectations of the company’s overseas bosses. The trick is to persuade them to invest in the country’s growth while also counselling patience when they demand to know why margin growth is not, at least initially, matching that of other emerging markets.
The conundrum was captured in a survey by Frontier Strategy Group, an business advisory company with a focus on emerging markets, which quoted an unnamed client with a consumer goods business as saying: “I know that Brazil is key to our long-term growth strategy, but my biggest challenge is that for every additional percentage point of growth that we see from Brazil, our overall regional profitability declines.”
Frontier Strategy estimates that the average net margin in Latin America is 10.5 per cent, or nearly a third of gross margins. In Brazil, net margins are 5.4 per cent, or nearly one-seventh of gross margin.
Manufacturers are generally worst hit by the Custo Brasil. A startling illustration of this is the Volkswagen Fox, a Brazilian-made car that has a starting price of more than R$32,000 ($18,660) but sells in the UK at just under £7,000 ($11,100).
The Brazil cost is also reflected in the country’s number 126 ranking out of 183 in the World Bank’s Doing Business report. Frontier Strategy details how it costs double a person’s salary to hire someone in Brazil because of taxes and welfare payments. Meanwhile, it takes 120 days to open a new business in Brazil compared with the OECD average of just under two weeks. So does all this mean that no one is making money in Brazil? No, it is just that the barriers to entry are higher. Companies must clearly identify those costs that are associated with Brazil and benchmark themselves against their peers to see whether their costs are in line with industry averages.
The next step is to develop a strategy that minimises the Custo Brasil – for instance, by identifying the fastest-growing regional markets within the country that have the best infrastructure. Or by finding a balance between targeting the wealthier but more mature south-east and the faster-growing but under-developed north-east.
Companies can also try to make the Custo Brasil work for them. The government is erecting barriers against imports but foreign companies that set up plants locally – such as in the automotive sector – usually enjoy the same protections as Brazilian ones.
Most important is that headquarters understands the equation that, at least in the early years, top-line growth in Brazil will not necessarily mean equivalent expansion of the bottom line.
Ask the shoeshine men. It is a safe bet that even though the São Paulo shoe shiner is earning more per shine, the cost of his brushes and polishing creams are a lot higher than for his brother in New York.
