As organizations re-evaluate global sourcing strategies, Brazil is positioning itself as a nearshore alternative

With a greater focus on reverse globalization and nearshoring, organizations are considering low-cost regions that are close to home. Brazil offers several substantial advantages for United States companies as both a sourcing destination and a consumer market.

Brazil as a Supply Base: How Attractive Is It?

The Brazilian economy has had its share of volatility since its accelerated industrialization after World War II. Decades of solid growth and expansion were followed by stagnation and decline. However, since Fernando Henrique Cardoso, a center-right reformist, took office as president of Brazil in 1994 and introduced the comprehensive economic recovery project, "Plano Real" including a new currency, things have turned around. In 1999, amid a stream of capital outflows, a recession and increased unemployment, the Brazilian government had to face the hard choice to devalue its currency, the Real. While Brazilians lost significant purchasing power relative to their former dollar-pegged currency, the country increased its competitiveness for exports, and jobs were created rapidly. Unlike many of their Latin American peers who sought refuge in the U.S. dollar during times of crisis, Brazilians adopted the new devalued Real and the economy carried on.

In 2003, under President Luiz Inácio Lula da Silva's left-leaning Workers Party, Brazil had another hard choice. The country's net public debt was more than 75 percent of GDP, and the Country Risk increased 20 percent, mainly due to the recent devaluation of its neighbor – and main trading partner – Argentina. Brazil faced a looming recession, and analysts began to worry that the recently elected leftist government would be forced to print money to meet the social spending commitments in the budget. Was Brazil going to emulate the default of Argentina and save needed short-term money, or carry forward with the effort and meet its debt obligations? Indeed, Brazil made the necessary payments and confidence increased. Permanent foreign direct investment poured into the country at record levels in the following years, setting the stage for strong economic growth and increased competitiveness.

The decision not to default on its debt and floating the exchange rate against the U.S. dollar not only strengthened Brazil's economy, but also confirmed the determination of the government to position the country as a global player. Brazil has clearly entered the new millennium, claiming more space in the market as one of the BRIC countries (Brazil, Russia, India and China), and has demanded a more prominent role in the G20 economic community. Most important, Brazil has become a more evident choice as a source of products and production.

Drivers for Brazil's Cost-Competitiveness as a Supply Base

Brazil's industrial base benefits from a number of advantages:

• The country's electrical power grid is mainly based on hydroelectric power plants, which produce inexpensive and sustainable energy.
• There is a favorable climate, which benefits agro-commodities and increases productivity compared to other industrial countries in the northern hemisphere, for nearly all crops, such as soy, sugarcane and even wood plantations.
• The wealth in natural reserves, such as iron ore of the highest quality, bauxite and new reserves of petroleum, makes Brazil relatively independent of global commodity shortages and has prompted the country to establish competitive value chains in steel and petrochemical production.
• Through innovative thinking in the 1970s, Brazil established a sustainable ethanol production and distribution network that today powers more than 80 percent of the passenger vehicles produced and sold in the country, making Brazil likely to be the first country independent of fossil fuels for its light vehicle fleet.

Brazil has leveraged these competitive advantages and become a global market leader in production and export of iron ore (with 8 percent of U.S. imports), pulp mill products (19 percent) and fruit and vegetable derivatives (3 percent).

With its government focused on establishing a strong manufacturing base, Brazil has seen accelerated industrialization in recent decades. Leading automotive OEMs established their manufacturing and assembly footprint in Brazil in three waves: 1) General Motors and Ford in the 1920s and '30s, 2) Mercedes-Benz and Volkswagen in the 1950s and 3) Fiat in the 1970s. This rampup established a solid domestic supply base for Brazil's basic industrial needs (foundry, stamping, mechanical components and the like) and contributed to building the culture of an industrialized nation – a clear reflection on the population's skills and choice of profession. In the mid-1990s, the country's growth and future market potential attracted another wave of OEMs.

Today, virtually all global mass-vehicle manufacturers have facilities in Brazil, further contributing to improving the automotive supply base in the country, maintaining an up-to-date technology profile and continuously driving industrial efficiency in a very competitive market.

Over the years, Brazil has developed a large and well-established local supply base, which makes several industry sectors virtually independent of imports and their associated risks (for example, supply chain and currency fluctuations). Severe import restrictions in the 1970s and '80s forced the development of a strong local second-tier supply base of family-owned companies (foundries, metal works, engineering and the like). Since then, these enterprises have been partly consolidated and integrated by global industry leaders. Still, a large network of smaller, entrepreneurial firms continues to support many industry sectors.

Another clear example of one of Brazil's successful attempts in establishing an important industrial capability is Embraer. Founded in the 1970s to develop the country's capabilities in the aerospace industry, the company is a global leader in regional civil aviation and is quickly establishing itself as a key competitor in the fast-growing executive aviation market. Since its privatization and entry in the regional jet business segment in 1995, Embraer has focused on establishing a competitive supply base for its production in Brazil, leveraging the country's favorable labor cost and making it less dependent on global currency fluctuations. Today, besides being an aerospace industry leader, Embraer supplies companies such as Boeing and Airbus with parts for their flagship airliners.

Brazil continues to have substantially lower labor cost compared to developed countries. Even with significant improvements in minimum-wage levels, which rose more than 50 percent over the last 10 years and are currently at about R$400 per month (US$200 per month), Brazil continues to be considered a low-cost country. Comparing trained labor in automotive production and assembly, labor costs in Brazil are five times lower than they are in the United States and nearly nine times lower than they are in Western Europe. The minimum wage increase in Brazil has had a positive impact on the working class, generating increased consumer demand and driving domestic markets to grow above the global average in a number of industries and helping to mature the Brazilian economy even further.

The relatively well-established industrial structures in a number of core mass manufacturing industries (such as automotive vehicles, heavy machinery, durable consumer goods, food and beverage, and the like) and a related industrial culture have generated an increasingly competitive base of human capital (workers, technicians and engineers) required to operate, maintain and optimize this growing industrial infrastructure. At the same time, the growth in human capital, talent and income has generated significant demand in local consumer markets. Brazil is a "top five" market for a number of prestigious NYSE-listed and leading European companies, such as Unilever, Avon, Nestlé and Volkswagen, among others.

China is also a "top five" sourcing and consumer market for many American and European companies. However, Brazil's proximity to the United States, in geography, absolute distance and time zone, results in comparably less risky, less expensive and more eco-friendly supply chains. For example, shipping routes do not pass through global areas of tension, such as the Gulf of Aden; freight rates are 30 percent lower than rates from Asia; and there are lower carbon emissions. Moreover, the western culture of Brazilian business leaders is more akin to that of traditional North American or Western European business leaders.

What to Watch For – Obstacles and Limitations

But not all is great in Brazil, and a number of obstacles have to be taken into account when considering the country as a supply base.

In a number of sectors, the industry structure does not provide the required scale to supply North American mass production industries. Volume ramp-ups have to be timed accordingly.

Despite great technological improvements in recent decades, technology barriers still exist in certain industry segments. This is especially true in advanced technologies, such as advanced vehicle electronics, where local know-how is not yet aligned with the global requirements and trends. In many cases, intensive supplier development efforts will be required to assure supply reliability while leveraging Brazil's cost advantages.

Even with the country's multiyear, multi-billion-dollar improvement plan, infrastructure continues to be a challenge. For a new exporter, establishing a new export flow usually requires a significant investment of time and skill to balance the right ramp-ups, capacity and reliability of shipments.

How to Source From Brazil

In general, the way organizations set up their capability to benefit from sourcing opportunities in low-cost countries (LCCs) varies significantly: from a timid use of a third-party agent, to a more established use of LCC procurement specialists (in the corporate center or in the local country), to the more advanced deployment of an international procurement office.

To effectively benefit from the country's cost advantages and source successfully from Brazil, it is necessary to actively manage outbound flows, assume an active role in the supply chain and, ideally, establish a local buying office and staff to control and qualify the local supply base and its capabilities.

Brazil can be a rich source o flow-cost alternatives for organizations interested in developing long-term relationships with suppliers that have advanced capabilities (for example, differentiated specs, quality and innovation). Brazil will offer not only a competitive advantage for such companies, but also a sustainable one.

By Ricardo Ruiz-Huidobro and Markus Stricker © Extract from Inside Supply Chain Magazine - september 2009