Riding the Rough Road Ahead by Innovating the Value Chain

By Isaac Abraham, Senior Research Analyst (BSIG), Automotive & Transportation Practice Vishwas Shankar, Senior Consultant and Program Manager (BSIG), Automotive & Transportation Practice

Brazil's initial wave of today's top 4 manufacturers—Fiat, Ford, General Motors (GM) and Volkswagen—came in towards the latter half of the 20th century. The second wave brought in manufacturers such as Daimler, Honda, Mitsubishi, and Toyota, riding on the economic stability witnessed in the late 1990s. Today, Brazil is one of the world's top 5 markets for passenger cars and light commercial vehicles, with over 3.2 million vehicles sold in 2014. The competitive landscape has been changing and the Big 4—Fiat, Ford, GM and Volkswagen—have been losing foothold in the market, from a combined market share of 87% in 1998 to 64% in 2014. This study attempts to throw light on the trends shaping the Brazilian auto market and on the areas to focus on for competitiveness in the future.

Overcoming complex and uncompetitive taxation

Brazil has always been a protectionist economy, with the government using state-controlled companies and unattractive levies to keep the jobs and technology within the country. This is slowly changing, with external pressure from the WTO and the EU, and the government realizing that it requires business-friendly policy to attract foreign investment.

Import of any goods into Brazil is subject to 5 different taxations: IPI (Industrial Production Tax or Excise Duty), social contributions in the form of PIS import (Programa de Integração Social, a social contribution tax), COFINS import (Contribuição para o Financiamento da Seguridade Social, a federal contribution tax), value-added tax (VAT), and customs duty. IPI rates vary based on the industry; at present, the government has withdrawn the subsidy introduced in 2013 to help boost sales. The overall prices of passenger vehicles are bound to increase not only due to taxation, but also because of regulations around vehicle safety, energy efficiency, and, possibly, even connectivity in the future. Furthermore, to reduce the impact of IPI, manufacturers, in line with the INOVAR directive, are aiming to increase and keep parts sourcing and manufacturing local. For example, Fiat just built one of its largest and most modern manufacturing facilities in the state of Pernambuco; it houses an onsite R&D facility and a supplier park to ensure that 70% of the parts are sourced in Brazil. Choosing the right location, based on logistics feasibility and favorable state taxations, is key to ensuring a competitive edge and absorbing price fluctuations.

Breakthrough innovation across the value chain

Despite being a protectionist economy, Brazil's focus on innovation and sustainable growth is highly commendable. The requirement for companies to reinvest 0.5% of gross operating revenue in R&D/innovation is one of the ways the government is trying to ensure growth in local technology creation/innovation and knowledge sharing within Brazil.

Purchase habits unique to Brazil

It is important to know the buying patterns of customers to help them make a choice of one competitor over another by creating value. Non-banking financial companies such as Banco GMAC S.A., and Banco Mercedes-Benz do Brasil backed by the manufacturers, are available to provide credit support to consumers. However, consórcio (consortium) is a very attractive medium of financing a vehicle for those who want to buy but are not in a hurry. In a consortium, the buyer pays only for the inflation-related cost escalation and not interest. As of January 2015, there were 2.61 million participants in consortium, 10.1% higher than in January 2014. This increase is attributed to the higher taxation that has made cars expensive and the cautious approach of banks to extend credit in the automotive industry.

Bricks and clicks

With increasing Internet penetration and high dealership concentration, Brazil's auto dealerships are looking to move online. A cross-touchpoint retail strategy shapes the customers' initial purchase sentiments online, drawing them to a store for a test drive and booking. Fiat's digital store, called 'Live Store', is based on a real-time concept, with sales personnel wearing innovative headgear to help customers personally experience the store in the comfort of their living room. The Live Store is estimated to have about 6 million visitors a month, on average, with over 60% of the visitors requesting a test drive thereafter, according to industry reports.

Economical plastics

The government's push toward sustainable business practices and tax breaks for innovation has driven Braskem, one of Brazils' largest petrochemical companies, and others to develop sugarcane-based ethanol and plastics that are economical and environment friendly. Braskem has also tied up with Michelin to explore possibilities to produce renewable isoprene with plant sugar.

Upselling to the next segment

In recent years, Brazil has witnessed the rise of its Class D (roughly 30% of the population). This growing consumer segment considers the best purchase in terms of technologically advanced and connected vehicles. As an example, in 2014, only 36% of all cars sold in Brazil used an engine capacity of 1000cm³ or below—compared to 2005 when over 52% of the cars sold had an engine capacity of 1000cm³ or below¹. Luxury manufacturers are optimistic and have announced setting up additional facilities to take advantage of growing demand. Mercedes has witnessed an average year-on-year growth of 35% for the past 2 years².

Collaborating to launch services

Auto manufacturers have, in recent years, ventured into delivery of services to look for allied revenue streams. Chinese manufacturer BYD has announced its plans to invest $100 million in a manufacturing unit to revolutionize the urban public transport network in Brazil. BYD is part of a group of companies that won a contract to develop a car-sharing system in Rio de Janeiro.

Advantage of 3D printing

One of the main factors in favor of the Big 4 (Fiat, Ford, GM and Volkswagen), is their sales-and-service network, which is spread across Brazil. Late entrants have had challenges to develop a reliable service-and-spares network in this vast country. 3D printing is likely to be a game changer in favor of late entrants by eliminating the need for a dedicated aftermarket presence.  A 3D printer, as an aftermarket or a job shop resource to print out any of the 20,000+ parts that an aftermarket store would usually carry, could potentially reduce the time and resources required to set up a network of aftermarket dealers and retailers.  Brazil's 3D printing technology potential is evident from the recent acquisition of Brazilian 3D printing company Robotech by South Carolina-based 3D Systems, a pioneer in industrial 3D printing.

This would enable high customization, faster processing, and minimal wastage, ensuring competitive costs despite the high taxation.

Despite challenges in terms of taxation and economic slowdown, Brazil has always been an attractive market even during high inflationary periods. The Big 4 certainly have increasing competition to face, and also need to align with the changing business landscape—the passenger automotive industry has never been as level a playing field as it is today.

Fields of Innovation, Brazil, 2014

With the right technology adoption, collaboration, scope for parallel revenue streams, and value addition, each manufacturer has the opportunity to look for white spaces within the market.