Protecting Profits and Managing Prices in Latin America

Companies are increasingly looking to adapt their pricing strategies and tactics to deal with macroeconomic volatility and shifting corporate mandates in Latin America.

As Latin America’s operating environment has become more volatile and bottom lines begin to receive more scrutiny from the corporate center, regional executives are focusing on how they can shift their pricing strategies to maximize profitability mandates while protecting volumes. FSG’s recent study Protecting Profits and Managing Costs: Pricing Strategies and Tactics for Latin America (clients only) focuses on the best approaches to manage pricing and maximize earnings in Latin America’s evolving operating environment.

LATAM Pricing ManagementIn this study, FSG concludes that multinationals’ approaches to pricing strategy are often dictated by organizational constraints, in particular  the degree to which regional teams have the capabilities to adjust prices in response to macroeconomic shocks. This depends in large part on how centralized both risk management and pricing strategies are within a given company.

Companies seeking to maximize the focus of local teams on executing a pre-determined market strategy often find that a centralized approach to pricing and risk management is optimal. By leaving the management of transaction and operational exposure to the corporate treasury, companies can help to ensure that local teams are not distracted by short-term fluctuations in the market environment.

However, a centralized approach to pricing and risk management often means that companies lose the ability to adapt pricing to local market conditions. This makes it more likely that an organization will leave money on the table or lose market share when adjusting prices.

To succeed, companies should ultimately seek to deploy a mix of hedging and operational strategies, coordinated across centralized and decentralized functions within the company. FSG’s study provides a set of best practices and case studies for companies to learn from and consider as they determine the optimal approach to pricing for their business in the region.

For FSG clients interested in learning more about these best practices, the full report is available here. Not a client? Contact us.

Central America Offers its Own Set of Challenges and Opportunities for MNCs

As Latin America’s largest markets have struggled in recent years, multinationals are taking a closer look at the opportunities that the smaller markets of Central America can offer, particularly they seek to diversify their regional portfolios. However, the opportunity must be kept in perspective, as Central America only represents around 3.5% of the Latin America’s GDP, making the region the eighth-largest market in Latin America, just behind Peru.

Graph 1 LATAM Blog Post

That said, Central America is expected to experience growth on par with some of the fastest growing markets in Latin America over the next few years. However, individual markets within Central America will experience widely divergent growth prospects, making prioritizing investments within the region absolutely essential.

  • Panama will remain one of the fastest-growing economies in the region, with multinationals increasingly considering the country as a viable hub for operations in Latin America
  • Costa Rica offers a solid business climate, but chronic budget deficits and legislative gridlock cloud its medium-term outlook
  • Guatemala, Honduras, and El Salvador continue to be plagued by weak government finances and drug-related violence, limiting the potential for higher economic growth that might alleviate these countries’ extreme poverty
  • Nicaragua is projected to experience solid growth over the next several years, in part because of its financial position, but the market also remains at risk of severe political and economic instability
  • Belize is suffering from high debt loads and limited opportunities for growth over the medium term

Graph 2 LATAM Blog post

FSG recently published a report that provides multinationals with an extensive overview of the region’s macroeconomic outlook, forward-looking market and industry sentiment, and deep-dives on each of these markets.

Chile’s Moderate Growth Path in 2014

As President-elect Michelle Bachelet prepares to take power in March, she will be tasked with responding to domestic demands for improved access to lower-cost, higher quality public services, including education and healthcare, and helping Chile to weather the impact of exchange rate depreciation and slowing growth, driven in part by weaker global copper prices.

Chile's Growth Trajectory 2014

Multinationals will be impacted by these dynamics in two primary ways:

  • Rising domestic demands and the need to fund ambitious education and healthcare reforms ensure that fiscal reform will be a priority. Corporate taxes are likely to rise from 20% to 25%, but Chile’s pro-market stance and sound economic management are expected to remain in place.
  • Currency depreciation and weaker copper prices will drag down gross fixed investment and pose pricing and profitability challenges for companies importing into the market. Companies selling capital-intensive goods and machinery will be most impacted, but the pass-through effects will be visible across the economy and will drag down expectations at the margins.

Copper Prices 2014

In general, the stage is set for slower, yet steady growth. Given strong labor market dynamics and relatively moderate price pressures, domestic demand will remain resilient, boding well for retailers. FSG clients can access our full Q1 quarterly report on Chile here.

Forging New Links: Overcoming Obstacles to Supply Chain Integration in Latin America

Latin America Supply ChainLatin America’s history of pervasive economic and physical trade barriers has proven a significant impediment to the integration of multinationals’ regional supply chains. Tariff and non-tariff trade barriers, complicated and inconsistent tax rules, and the nearly-impenetrable Amazon Basin and Andes Mountains have forced many companies to take an ad hoc approach to supply chain development in Latin America.

This ad hoc approach has meant that supply chains in Latin America are often a fragmented and inefficient drag on bottom-line performance, rather than the streamlined competitive advantage they can be in developed markets. Indeed, according to a report by JDA Software Group, longer lead times and less flexible supply chains means that days inventory outstanding for manufacturers averages 133% higher in Latin America than in the US, while days inventory outstanding for retailers averages 77% higher.

Despite these impediments to supply chain integration, growing corporate pressure to improve bottom-line performance, coupled with the threat posed by increasingly sophisticated local competitors, is causing some savvy LATAM executives to take a second look at opportunities to improve supply chain performance. Supporting this trend are emerging regional supply chain enablers like the recently-enacted Pacific Alliance agreement, growing government investment in transportation infrastructure, and the deepening presence of world-class third-party logistics providers.

Major companies taking advantage of these enablers include Diageo and Proctor & Gamble, both of which recently announced investments aimed at consolidating their Latin America supply chains. Companies that are able to differentiate themselves by cutting costs and improving customer service through supply chain integration will find themselves better positioned to navigate growing competitive threats as Latin America enters a phase of stronger macroeconomic headwinds.

Tomorrow’s Latin America Won’t be Won with Yesterday’s Playbook

Frontier Strategy Group is witnessing a dizzying array of changes to the business landscape in Latin America. Some are highly visible shifts in the external political and economic conditions in key markets such as Brazil, Mexico, and Venezuela, to name a few, while others involve subtle evolutions in internal corporate mandates for Latin American business units of multinational corporations. For this reason, FSG recently released a new Regional Overview of the factors influencing the results of our clients as well as emerging trends likely to impact performance and shape strategy for the coming years. The research is drawn from extensive interviews with senior executives at leading multinationals, independent experts, and analysis of surveys of FSG’s client base. Below are featured trends from the report, accessible to FSG clients:

Economic Performance is Strong, but Risk – and Skepticism – is Growing
Compared to global averages, and even in comparison to other emerging market regions, Latin American growth remains, in the aggregate, relatively robust. Yet many industries in Latin America in 2012 either just met or underperformed expectations, and now with a persistent slowdown and protests in Brazil and crisis always on the horizon in Venezuela and Argentina, skeptics are growing louder, forcing executives to justify further investments in the region. Furthermore, FSG’s data indicates that slow growth in Argentina, a weak Q1 in Mexico, and the devaluation in Venezuela threaten goal attainment of sales targets in 2013 as well.

2013 Performance Targets in Key LATAM Markets

2012 Sales Performance by Sector in LATAM

Latin America Splitting into Two Distinct Groups: Pacific and Atlantic
The dynamic Pacific economies are integrating rapidly, as evidenced by the creation of the Pacific Alliance trade group, creating new trade dynamics and opportunities for increasing scale and reorienting supply chains. In contrast, the Atlantic economies are increasingly insular and crisis prone, a trend typified by the increasingly dysfunctional Mercosur customs union. These distinctions are growing and becoming more tangible as companies position to mitigate risk from reliance on Mercosur and maneuver to gain from new opportunities presented by the Pacific Alliance.

The “Grow-fast, Worry about Profitability Later” Days are Coming to an End
Many executives perceive a strong shift in corporate mandates for Latin American business units towards bottom line results, rather than purely on top line growth. This shift is changing the way executives prioritize markets, evaluate organizational structures, measure and orient workforces, and make the case for resources.

New Blueprints for Success
As both internal corporate and external dynamics have changed, senior executives are drawing up new blue-prints for success by examining existing assumptions around optimal organizational footprints and structures and by prioritizing markets and communicate opportunity based new criteria such as relative profitability and operating margins.

3 Year Growth Outlook v Relative Profitability

Conclusion
FSG’s LATAM Regional Overview expands on these trends and shares analysis of client survey responses on how they are responding to these shifts. FSG believes that despite increasing volatility and growing macroeconomic and political risks, Latin America continues to offer excellent opportunities and high returns relative to other regions. That said, today’s business environment already is significantly different from that of just a year or two ago, and regionally-focused executives are wise to recognize that their strategies must evolve in tandem.

Latin America’s Moment: Making the Case and Capturing Opportunity

Making the Case for Latin America Has Historically Revolved around the Region’s Untapped Growth Potential

Making the case for resources has long been a challenge for emerging markets executives—while emerging markets represent tremendous growth opportunities, they have historically been viewed as risky, volatile, and fragmented, undermining corporate willingness to commit large amounts of resources. On a regional level, many of the Latin America executives we work with have expressed frustration at having to defend the region’s potential when top-line growth has been higher elsewhere in the world, particularly in Asia.

At Frontier Strategy Group, we have long strived to help our clients overcome such skepticism and communicate upwards effectively by emphasizing the region’s hard-won macroeconomic stability, relatively under-penetrated markets, and growing middle class. While these drivers remain in place and multinationals’ growth targets for Latin America are now on par with those seen in Asia, sluggish global growth has raised the stakes, and emerging markets are increasingly expected to deliver both top- and bottom-line growth.

However, Sluggish Global Growth & Underperformance in 2012 Have Undermined Confidence in Latin America

In the wake of Venezuela’s recent devaluation and the death of President Hugo Chávez, as Argentina continues to impose heterodox capital and import controls and Brazil edges towards stagflation, it is easy to understand why multinational executives face growing skepticism from risk-averse corporate centers as they strive to make the case for resources in Latin America.

Fortunately, Executives Compelled to Reassess the Region’s Potential Can Walk Away Reassured

While we certainly acknowledge the endogenous and exogenous factors undermining Latin America’s near-term outlook, we remain bullish about the region’s potential over the medium-to-long term, and our optimism is grounded in a demonstrable belief that the region’s core advantages have in fact remained intact, and will be reinforced by positive secular trends.

Not Only Do Latin America’s Core Advantages Remain Intact…

Latin America’s core advantages can be divided into four buckets, including profitability, relative growth, stability, and concentrated financial resources. Of these four advantages, profitability stands out as the most salient given the pivot to profitability that emerging markets executives are experiencing. As growth remains stalled in developed economies and corporate places increasing pressure on emerging markets, 73% of FSG clients in Latin America have experienced or expect to experience a shift in corporate emphasis towards bottom-line growth over the near-term. With this in mind, it is certainly reassuring to consider that available data on publicly traded companies indicate that average operating margins in Latin America are 55% higher than in the BRICs excluding Brazil.

At present, Latin America derives its profitability advantage vis-à-vis other emerging market regions primarily from a host of demand-side factors which allow multinationals to sell at higher margins and maximize the gains associated with realizing economies of scale. However, these advantages have the potential to diminish over time as competition within the region increases, meaning the time to build market share and brand loyalty is now.

When it comes to GDP growth, while the pace of growth in other emerging markets is expected to decelerate in comparison with pre-crisis rates, LATAM has remained relatively resilient and will accelerate in the coming years.

If you’re tempted to dismiss growth and profitability out of fear of resurgent instability, think again. More conservative corporate centers have historically associated Latin America with hyperinflation, uneven growth, and overexposure to commodity boom-and-bust cycles. Part of the story we’re striving to help our clients communicate is that while these sorts of risks persist in specific markets, the region as a whole has progressed tremendously thanks to orthodox macroeconomic reforms.

Inflation targeting regimes, reduced deficit spending, and the liberalization of trade and capital flows have brought down inflation, empowered consumers and provided the stability necessary for sustained growth. Latin America also remains well-positioned to ride out any future global downturn, as its economy is less dependent on trade than APAC, and less integrated into the global financial system, reducing the risk of Eurozone contagion. Concentrated financial resources also bode well for B2C and B2B multinationals—per capita private consumption spending and government expenditure in LATAM outpace other EM markets including India and EMEA, and are on par with China.

But investment and reform are positioning the region to build on these strengths moving forwards, unlocking new opportunities for multinationals:

Most importantly, Latin America is well-positioned to build on these core advantages, and secular trends are already yielding proof points. Trends we’re tracking range from Peña Nieto’s ambitious reform agenda and the resurgence of manufacturing in Mexico to Colombia’s peace dividend and Peru’s rapid rise. On a pan-regional level, energy resources will bolster government coffers and empower investment in infrastructure and human capital, while the rise of the Pacific Alliance will provide a decidedly pro-business counterweight to the increasingly anachronistic Mercosur. The region is on the rise, and there has never been a better moment to make—and win—the case.

Emerging Market View: What Our Analysts Are Reading – 3/8/2013

Here’s a look at a few of this week’s global headlines with added commentary by our research team members:

Market Watch’s Post-Chavez Venezuela: oil’s next Saudi Arabia?:

“As Associate Vice-President for Latin America Clinton Carter is quoted in this article, oil production is unlikely to experience any increase over the short term, as a necessary shift toward investments in PDVSA are likely to continue to be secondary to the need to fuel social spending and support any post-Chavez government.”
- Antonio Martinez, Senior Analyst for Latin America Research

The Financial Times reports new property market cooling measures put doubt on China’s economic recovery:

“China has launched yet another round of of cooling measures, including a 20% capital gain tax on property sold in the secondary market, higher down payment and mortgages, to contain property prices. This is will impact property and construction related industries, which represent a big chunk of the Chinese economy, adding new pressure to the fragile recovery.”
- Shijie Chen, Practice Leader of Asia Pacific Research

Reuters had an article on Brazil’s industrial recovery:

“Any sustainable economic rebound in Brazil will have to be led by the industrial sector, making this heartening news for multinationals concerned about a seemingly interminable slowdown in Latin America’s largest market.”
– Ryan Brier, Practice Leader of Latin America Research

Hugo Chavez’s Death: Considerations for Multinationals

According to Venezuela’s vice president, Nicolas Maduro, Hugo Chavez died at 4:25 PM, local time, on Tuesday from complications related to cancer.

FSG has been predicting for some time that it was unlikely that Hugo Chavez would be able return to lead the country, as his health has been in serious decline since he underwent his fourth cancer-related surgery in December.

While there might be a temptation for multinationals with operations in Venezuela to greet this news with cautious optimism, FSG stresses that executives should focus on managing expectations for any material change in the operating environment over the near-term.

The government is constitutionally mandated to hold presidential elections within 30 days; however, there is a possibility that this requirement could be ignored, with elections falling as far out as June.

Regardless of the timing of the elections, the most likely candidates will be Vice President Nicolas Maduro and Governor Henrique Capriles. FSG expects Maduro to win a clear electoral mandate due to a strong sympathy vote as well as the relative weakness of the opposition, which is still suffering the after effects of two big electoral defeats at the end of 2012. Recent poll results casting Maduro as a legitimate heir to Chavismo bear this prediction out.

Given Maduro’s ideological affinity for the key social tenets of Chavismo, as well as the fact that most legislators will not be up for reelection until 2015, it is highly unlikely that multinationals will see any major policy adjustments over the near-to-medium term. The one exception to this is a probable second devaluation sometime after the elections, along with the establishment of a new parallel exchange rate system to replace SITME.

The long-term picture is somewhat more optimistic as it is unlikely that Chavismo will hold together as a cohesive political force without a strong and charismatic leader at the helm. As such, there is a strong possibility that the opposition will slowly gain strength, leading to a modest opening of the economy to investment over the next few years. While this would be a welcome scenario for multinationals, it is also one fraught with a good deal of risk if the fragmentation of Chavismo leads to social unrest and instability.

 

Brazil’s Tech Execs are in for the Long Haul

I spent last week in São Paulo meeting with GMs of Brazil and Latin America based there. Among the highlights was a working breakfast with eight country and region heads of US technology and telecom companies. My colleague Antonio Martinez shared the LATAM research team’s latest outlook for Brazil and the region, and we had a robust discussion about the Brazilian business environment and its proper place in the Latin America portfolio. Here are a few of my top takeaways:

  • Tech has outperformed other industries recently in Brazil, but individual corporate performance divides largely by maturity in the market. Established firms are more impacted by the overall economy’s slowdown, but Brazil’s massive size still allows for rapid growth for tech companies that bring something innovative to the market.
  • Brazil’s fragmented tax regime is the biggest headache for country managers. The complexity of state and local tax codes (companies must comply with >200 taxes!) adds to the cost of doing business and impedes companies’ ability to expand into fast-growing cities beyond the highly developed southeast, especially in northern states where millions of people are taking on middle-class spending habits and governments continue to invest heavily in infrastructure. From the LATAM perspective, Mexico’s simple, if higher, tax rate looks better and better.
  • Country managers are in an uncomfortable dialogue with corporate headquarters. Top execs in the US are used to the BRICs story and are having a hard time wrapping their heads around the constant flow of downward revisions in the government’s growth forecasts. Everyone around the table believes in Brazil’s medium term growth prospects (on a 4-5 year horizon), but managing expectations for 2013 is tough. Particularly challenging is helping HQ understand currency volatility and inflation.
  • Horror stories about Brazil’s political culture were abundant. “Labor litigation is becoming a monster.” “The political mentality is: for the friends, everything, and for everyone else, the law.”  But frustrations aside, the group was unanimous in its belief in Brazil’s long-term opportunity and commitment to invest. The lessons learned and innovative practices shared around the table – some of which our clients may well see in case studies later this year – were the true highlight of the session.

Next week I look forward to sharing insights from a similar executive breakfast I’ll be attending in Shanghai, discussing the long-term outlook for China.

 

Emerging Market View: What Our Analysts Are Reading – 2/15/2013

Recent economic headlines reflected what FSG’s research reports have indicated around the world.  Ranging from the economic implications of the Syrian civil war to Argentina’s controversial elections and Estee Lauder’s successful EM portfolio, here are a few articles that our analysts read this week pertaining to emerging markets:

Estee Lauder reported big success in emerging markets via MSN Money online Emerging markets drive Estee Lauder’s profit growth:

“Not surprising that the Asia Pacific region was the largest contributor to Estee Lauder’s sales growth.  From a global perspective, we are noticing an uptick in consumer goods companies that are prioritizing the strong consumer environments available throughout the region.”
-Sam OsbornSenior Analyst

The Financial Times’ Beyondbrics blog, centered on emerging market news, posted an interesting entry about Vote buying in Latin America:

“The numbers validate FSG’s view that Hugo Chavez essentially bought his reelection in 2012 with huge increases in public spending, for which the country is now suffering a hangover. This article highlights other countries with a strong propensity to inflate the economy prior to elections, of relevance in 2013 to the growth outlook in Ecuador and Argentina in particular.”
-Clinton CarterHead of Latin America Research

The Washington Post reported Syrian business exodus gains pace:

“Syrian businessmen are shifting their investments, operations, and focus abroad amid increasing chaos of the civil war.  FSG mentioned how this impacts Jordan and Lebanon in the recently released MENA regional overview. This article also cites examples involving Egypt and the UAE.”
- Matthew SpivackPractice Leader for the Middle East and North Africa

*Post compiled by Hal Olson