The new global reality how the forces of globalization are reshaping business in latin america

The new global reality How the forces of globalization are reshaping business in Latin America... 1 How the forces of globalization are reshaping business in Latin AmericaFulfilling Lati

The new global reality How the forces of globalization are reshaping business in Latin America

1 Introduction 2

2 Business responses to globalization:

thriving in a globalized world 4

3 Measuring globalization trends in Latin America 10

4 What’s next 19

1 How the forces of globalization are reshaping business in Latin America

Fulfilling Latin America’s promise

In recent years, the business and political worlds have been looking hopefully to the East Eastern Europe, the Middle East and the emerging Asian economies have largely justified this hope through their rapid growth and development In our globalizing world, economic power is not only shifting east, however, but also south And when we look south to Latin America, we see a region that is starting to fulfill its vast promise

Blessed with plentiful natural resources, a young workforce and a thriving entrepreneurial culture, the region is quickly moving beyond the political and economic problems of the past and taking its rightful place on the world stage As with any region, though, wide variations exist and generalizations about the whole can be misleading

In January, Ernst & Young, in cooperation with the Economist Intelligence Unit (EIU), published The Globalization Index, which looked at the relative levels of global engagement of the world’s 60 largest economies Here, to coincide with the 2010 World Economic Forum on Latin America, we have focused on the Latin American countries that were part of our Index We have examined the similarities and differences

of these countries from a business perspective, and highlighted the implications of how globalization is affecting Latin America and, importantly, how Latin America is affecting globalization

James S Turley Chairman and CEO Ernst & Young

1 Introduction

Over the past two decades, Latin America has steadily deepened its integration with the global economy Trade and investment regimes have been liberalized, foreign direct investment (FDI) has increased and new export markets have come on stream The region now attracts around 7% of global FDI and accounts for 6% of global exports.

Latin America was not as badly affected by the global recession as

OECD countries, though it performed worse than other emerging

markets, notably India and China, which continued to grow

strongly Real GDP fell by an estimated 2.3% in Latin America in

2009, compared with 3.4% in the OECD However, the aggregate

regional figure disguises divergent trends, with a generally stark

divide between countries heavily dependent on the US market (on

the whole these performed worst) and those with stronger trade

links to Asia (these proved more resilient)

Of the latter, Brazil, the largest economy, barely contracted

(falling by 0.3%), even against a strong base of comparison

(GDP grew by 5.1% in 2008) This resilience reflected several

strengths, including a high degree of diversity of export industries

and markets, a solid and mostly domestically owned financial

system with minimal exposure to subprime securities and a large

state banking system Chile is a good example of a particularly

well-managed economy; despite being acutely exposed to the

downturn in world trade owing to the weight of the export sector,

substantial fiscal savings enabled an effective counter-cyclical

policy that restricted the contraction to 1.5% Mexico, the region’s

second largest economy, accounting for a quarter of regional GDP,

performed worst, posting a 6.6% contraction; it relies on the US

for over 80% of export sales, the lion’s share of FDI and significant

inflows of worker remittances; its weak public finances prevented

it from undertaking meaningful counter-cyclical policies

Recovery is at hand Latin America has long held huge promise

as a prominent actor in the global economy With abundant

mineral and hydrocarbon wealth, fertile land and the largest

tropical forests in the world, the region boasts a rich and varied

supply of natural resources Yet, until recently, it has been slow

to capitalize on this wealth, thanks to a long history of economic

mismanagement and a general suspicion of free markets

The US remains the main export market outside the region,

and still accounts for close to 40% of export sales But

fast-growing Asian markets, hungry for Latin America’s minerals and

agricultural products, are consuming a growing proportion of

exports For example, China’s share in trade has risen significantly

in the past decade, approaching 10% of export earnings and

import spending In 2009, the Brazilian and Chinese Governments

signed a deal between Sinopec, the Chinese oil company, and

Petrobras of Brazil, through which the Chinese would lend US$10b

John Ferraro

Chief Operating Officer — Ernst & Young

“In the coming decades, Latin America looks as if it will start to achieve its potential.”

Intra-regional trade has also been growing, but integration remains relatively shallow Latin America’s difficult topography and decades of underinvestment in infrastructure contribute to high transaction costs But institutional weaknesses have also been to blame, and official trade groups within the region have a checkered history Mercosur, the Southern Cone customs union, has been plagued since its inception in the mid-1990s by trade and investment disputes between its two major economies, Brazil and Argentina, and the Andean Community has been split

by factionalism

As Latin America continues to open up to international trade and investment, companies in the region are growing in confidence and reach Some, such as CEMEX from Mexico and Embraer from Brazil, have already become sizable global players in their respective industries Others from Brazil, such as the mining firm Vale, the food manufacturer JBS Friboi and the cosmetics company Natura, are wielding increasing international influence Equally, multinationals from Europe and North America, facing stagnant growth prospects in their own markets, have been increasing their exposure to Latin American markets With a political and legal environment that is steadily improving, and

How the forces of globalization are reshaping business in Latin America 3

About this report

The new global reality: how the forces of globalization are

reshaping business in Latin America is an Ernst & Young

report, written in co-operation with the Economist Intelligence

Unit, examining the degree of globalization in Latin America

Ernst & Young selected for analysis six of the eight countries

(excluding Venezuela and Ecuador) that were included in The

Globalization Index created by the Economist Intelligence

Unit, published in the January 2010 Ernst & Young report,

Redrawing the map: globalization and the changing world of

business To view this report go to www.ey.com/globalization.

2 Business responses to globalization:

thriving in a globalized world

Multinational companies have long had high expectations for Latin America, but many have been frustrated by the experience of investing there The region’s abundant natural resources, mostly

democratic governments and large, middle-income population offered great promise to businesses seeking to expand overseas Yet, all too often, optimism led to disappointment as companies

encountered a difficult operating environment and unfavorable political and economic policies.

Multinationals may have struggled with the unpredictability of

Latin American business, but for local companies this environment

is all they know As Donald Sull, Professor of Management Practice

at London Business School, noted in our recent report Redrawing

the map: globalization and the changing world of business

(January 2010), emerging-market companies have turned the

ability to thrive in a difficult environment into a key strength

“Companies from developed countries, by and large, have the

advantages of absorption — size, established brands, technology,

diversification and so on,” he says “Lacking these advantages,

emerging-market firms typically rely on agility To me the

striking thing is how fast agility can trump absorption.” He points

to the extraordinary rise of Brazil’s AmBev in global brewing

as an example

The key insights are:

Local companies are becoming global players

Companies based in Latin America are used to operating in

a challenging business environment In recent years, they have been leveraging this experience to embark on an unprecedented phase of global expansion

Foreign firms are re-engaging with Latin America

Facing sluggish performance in their domestic markets, companies from a wide range of sectors are looking to Latin America as a key source of future growth But the new wave of investors must tailor products and services to suit customers

in the regions, rather than merely import western products

The availability of technical and managerial skills remains

a concern

Public education is poor across much of the region, and a shortage of skilled workers bumps up managerial salaries to unrealistic levels Government policies protecting the local labor force restrict the ability to import key skills

5 How the forces of globalization are reshaping business in Latin America

Local companies are becoming global players

Steve Howe

Managing Partner, Americas — Ernst & Young

“Latin America is starting to produce companies that are world-class Just think of names such as CEMEX or Petrobras.”

Latin American companies that have grown up with a challenging

business environment are now using this experience to guide

them in a phase of global expansion Particularly in Mexico and

Brazil, emerging-market multinationals are coming of age Boston

Consulting Group’s 2009 list of Global Challengers — the

emerging-market multinationals that are evolving into global players — lists

14 firms from Brazil, seven from Mexico, two from Chile and one

from Argentina

Mexico’s CEMEX is a case in point In recent years, a series of

overseas acquisitions has propelled the company from being a

predominantly domestic manufacturer of cement to becoming one

of the world’s largest Its acquisitions have included RMC in the UK

and Rinker in Australia, although this buying spree left CEMEX with

a significant debt burden that it was forced to restructure

in 2009

During the recent downturn, Brazilian companies have remained

among the most active players in the M&A market The Brazilian

mining company Vale recently acquired assets from Rio Tinto and

also increased its stake in the German steelmaker ThyssenKrupp,

while food producers Perdigão and Sadia, also from Brazil,

announced a merger to create the world’s largest poultry company

by market value “If Brazilian companies do not follow the

internationalization path, they will not become competitive as a

whole,” says Luiz Augusto de Castro Neves, Brazil’s ambassador

to Japan

Other Brazilian companies are also competing to become global

players in the food industry JBS, with a mainly domestic market,

is now the world’s largest food company in the beef sector,

following acquisitions in the US and Australia “At some point

you cannot only be an exporter,” says Marcus Vinicius Pratini de

Moraes, an adviser to JBS “You have to become an operator.”

Within the past five years, JBS has invested around US$2.5b

overseas, and now operates in Argentina, Australia, the US and

the European Union (EU) BNDES, the Brazilian development

bank, has played an important role in financing JBS’s overseas

expansion, particularly with its recent acquisition of the US

company Pilgrim’s Pride, and holds a 20% stake in JBS “BNDES

has been very innovative in financing investment from Brazilian

companies abroad in order to stimulate more stable trade flows,”

says Pratini

Brushing off earlier disappointments with investments in Latin

America, multinationals from the US and other developed markets

are entering a new era of engagement with the region If anything,

the financial crisis has accelerated this trend Facing sluggish

performance in their domestic markets, companies from a wide

range of sectors are looking to Latin America as a key source of

future growth

DuPont, the science-based products and services company,

reported 2008 revenues of US$3.6b in Latin America, which

represents 12% of its global total Fifteen of its 75 R&D centers

are based in Latin America, with 11 in Brazil

Globalization has “created much greater expectations for Brazil’s

contribution to the company’s global portfolio,” says Roberto Hun,

Vice President for Finance at DuPont Latin America “This share

has been increasing, and the prospect in coming years is that a

large part of the growth will come from markets such as Brazil.”

Successful investment in Latin America depends on a thorough

understanding of local preferences and tailoring products and

services to suit customers in the region “As a science-based

company, we need to develop products that meet the specific

characteristics of the local market,” says Hun “In the past, we

would tend to copy an existing model that we had in other parts

of the world Now, products are more adjusted to the local

consumers’ needs as well as the local culture.”

For example, DuPont has conducted in-depth research among

the low-income population of Mexico to assess how it could better

meet their dietary needs The company found that families in this

socioeconomic group wanted to consume more beef, but could

only rarely afford it “Putting beef on the table is evidence that

they can take care of the family,” says Eduardo Wanick, Global

Leader of DuPont’s Emerging Market Growth Initiative

In response to this demand, DuPont created SoleCina™, a blend

of texturized soy protein, wheat, gluten, mechanically de-boned

chicken and flavorings “It is more nutritious than beef, it has

less fat and it is 30% to 40% cheaper than second-grade beef in

Mexico,” says Wanick SoleCina, which is now available in Mexico

and Central America, will enter Brazil as the next market, although

the program will need to be adapted to the local economy, because

beef is cheaper in Brazil than in Mexico

Multinational companies hoping to execute a broad-brush

“Latin American” strategy are likely to be disappointed Instead, they need to adapt a more granular approach that takes into account the regional differences Countries such as Brazil are not homogeneous entities, but have highly diverse populations, cultures and topographies This means that local preferences can vary widely from one region to another “Brazil is a country

of continental proportions with specific characteristics in each region,” says Alexandre Costa, Regionalisation Director of Nestlé Brazil

Festivals form an important part of Brazilian culture, but are often regional rather than national affairs As part of its regionalization strategy, Nestlé is careful to align its marketing efforts with these local celebrations In addition to the famous Carnival in Rio de Janeiro, the company takes advantage of marketing and sponsorship opportunities at other local festivals, such as São João in Recife and the state of Pernambuco, and Farroupilha in the south of the country

Products are also customized to suit local preferences For example, Nestlé recently opened a special plant in Feira de Santana, in the state of Bahia, to supply the region As local incomes are low, this factory produces versions of its products that are sold in fewer quantities and in cheaper packaging

As we also noted in our Redrawing the map report, this is similar

to an approach taken by Procter & Gamble (P&G) An estimated 80% of P&G’s customers in Mexico, for example, shop at informal stalls and kiosks, or “high-frequency stores.” In aggregate, these tiny outlets comprise P&G’s largest customer — bigger even than Walmart So P&G thinks first about what these customers can afford, and then works back Poor customers typically get paid daily and can’t buy in bulk So P&G sells its products in smaller packages and quantities, and prices them in rounded denominations that match local bills and coins Meanwhile, a network of local representatives supplies stallholders with stock and promotional materials

Foreign firms are re-engaging with Latin America

Like any FDI, Renault has to contend with an unfamiliar operating environment and bureaucracy Although conditions for foreign businesses have improved significantly in

the region over the past decade, challenges remain that require local knowledge and understanding to address

“Manufacturing abroad is not only signing a check, setting up a plant and churning out cars,” says Tissier “We have to rethink logistics and rediscover bureaucracies.”

Although Renault uses expatriates in its Latin American operations, Tissier believes that one must also build up and make use of local workforces “You have to resist the temptation to copy one model and paste it in a new country,”

he explains “You have to integrate with the local environment.”Also important is the need to strike the balance between centralization and decentralization Over the years, the company has delegated an increasing proportion of responsibility to regional heads, but there continues to be a strong link with corporate headquarters “We are not totally autonomous, but we cannot be piloted only by the central organization when we sell 120,000 cars per year,” says Tissier “You have to find a new balance, but it is not that simple in terms of the decision-making process in a fast-changing market.”

7 How the forces of globalization are reshaping business in Latin America

Case study: Renault

Like many multinationals, Renault has been turning its

attention to the faster-growing markets of Latin America,

which generally offer better growth prospects than the more

stagnant, saturated markets of Europe Although the car

maker has been operating in the region for some time, it has

recently ramped up its operations and sales Ten years ago,

Brazil was Renault’s 15th largest market; today it is its fifth

Renault manufactures its cars locally, partly to avoid

expensive tariff barriers, but mainly in order to get close

to its end customers Rather than sell the same cars in

Latin America as in Europe, Renault recognizes that it

needs to adapt its products to meet the specific needs and

expectations of local markets “Once I decide to manufacture

products away from my headquarters, I have to rethink my

products, to look at them differently,” says Alain Tissier,

Executive Secretary to the CEO of Renault Mercosur

This means using common elements, such as seats,

engines and gearboxes, to achieve economies of scale, but

customizing certain features for each market Even within

Latin America, adjustments are made for specific countries

“In Brazil we insisted that the quality of the interior of the car

is more visible than in Colombia,” explains Tissier

Jorge Menegassi

Managing Partner, South America — Ernst & Young

“When you try to discuss the downturn with Latin American business leaders their usual response is, “Downturn?

Let’s talk about the recovery.””

In our Redrawing the map report, several interviewees highlighted

the importance of hiring locals and ensuring that there was not

an over-reliance on expatriate workers Brian Wilkinson, a board

director at Randstad, a recruitment company, notes that the

focus on locals “has helped us shape a much more cosmopolitan,

international management team that’s more in tune with the

business wherever we do it.”

But the availability of managerial skills can be a concern in Latin

America With a few salient exceptions, the public education

system is poor and, given weak public finances across much of the

region, is likely to remain so in many Latin American countries In

addition, a short supply of highly skilled workers in many countries

can lead to salaries for senior managerial positions that are higher

than in the developed world

In Ecuador, for example, foreign businesses find it difficult to

identify specialized labor to fill senior and management positions

The problem is similar in Peru, and is compounded by the legal

situation regarding recruitment By law, 80% of the labor force

must be Peruvian and there is a 30% ceiling on the portion of the

payroll distributed to foreign workers In combination, this skills

shortage and regressive measures regarding the hiring of foreign

workers are likely to hold Peru back from moving up the global

value chain and attracting FDI

In the region’s larger economies, especially Brazil and Mexico

(which together account for 66% of the region’s GDP), the private

sector is beginning to play a crucial role in upgrading the skills

base through public-private cooperation on targeted training

programs But across Latin America, there is considerable

progress still to be made, and this factor could hamper FDI over

the medium term

The availability of technical and managerial skills remains a concern

9 How the forces of globalization are reshaping business in Latin America 9

The Globalization Index developed for this report measures

and tracks the performance of the world’s 60 largest countries

according to 20 separate indicators that capture the key aspects

of cross-border integration of business The indicators fall into five

These factors have been weighted (ranging from 17% to 22%

for each) based on the significance placed upon each factor by

520 surveyed senior company executives doing international

business Subsidiary indicators are also given sub-weightings

within each category Indicators chosen include both quantitative

data and qualitative scores from a range of trusted sources The

performance of countries is measured over time, so that progress

toward greater or lesser globalization since 1995 can be observed,

with a forecast of likely performance until 2013

The Index measures “relative” rather than “absolute” globalization

This means that a country’s trade, finance and capital investments,

labor, technology and cultural integration with other countries is

measured relative to its GDP rather than by the absolute value of

these elements being exchanged As a result, smaller countries

that depend on international integration will tend to have a high

level of globalization, while larger countries that can rely on a big

domestic market will tend to have a lower level, even though the

total amounts exchanged internationally may be much greater

The Index, therefore, reflects the degree to which the global

integration of a country is observable or experienced from within

that country

The key insights are:

Globalization remains slow

Although the overall trend in Latin America has been toward

a gradual opening up of markets and greater engagement with the global economy, there is considerable variation across the region Of the eight Latin American countries that appear in The Globalization Index of 60 countries, only one, Chile, makes it to the top half of the Index

Technology adoption lags

A general trend among the eight Latin American countries is their weak performance on the Index for the exchange of technology and ideas Encouraging steps in some countries include funding for R&D and the growth of public-private partnerships

3 Measuring globalization trends in

Latin America