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Navigating Latin American Distribution Channels

Sept. 18, 2007
In urban areas, the arrival of modern retailers in the form of global supermarket, hypermarket and club stores has shaken up traditional channels made

In urban areas, the arrival of modern retailers in the form of global supermarket, hypermarket and club stores has shaken up traditional channels made up of owner-operated independent retailers built upon inefficient layers of intermediaries. B2C e-commerce has certainly changed the way Latin Americans buy travel services and read newspapers; however, marketers would be mistaken to abandon independent and informal channels of retail that still represent more than three-quarters of Latin American retail for fast moving consumer goods. Instead, successful marketers must master multiple channels, even at the risk of cannibalizing their own sales in a single channel.

Formal Latin American retail sales are expected to reach US$1 trillion in 2010. Understanding how channel structure will look three years from now warrants study of what is driving the growth or decline of each channel.

• Independent (non-chain) retailers account for 60% of all instore retail but are gradually losing market share to modern retailers in the area of fast moving consumer goods.

• Modern retail comprises roughly 40% of in-store retail sales, mainly through hypermarkets and supermarkets. Middle-to-upper-income consumers generally prefer modern retailers. Mass consumer segments continue to prefer shopping through independent retailers and informal channels (street vendors, markets) but will gravitate to modern retail as wages, car ownership and credit card penetration grows.

• The direct (or multi-level) sales format has proven to be very effective in Latin America, accounting for roughly 75% of nonstore retail sales. The channel is particularly effective for selling cosmetics and health products.

• E-commerce constitutes 15% of non-store sales but less than 1% of total retail. Online sales are growing faster than any other channel. However, challenges in delivering physical products limit the viability of e-commerce to digital products (travel, music, software) as well as hard-to-find IT hardware.

• Home shopping (catalogue and infomercial sales) accounts for about 9% of non-store sales and will continue to lose market share as it is easily replaced by internet sales.

• The informal economy remains the most important channel for distributing goods to consumers, accounting for an estimated 50% fast-moving consumer goods (See Figure A). In spite of the inroads made by modern retailers, the informal economy continues to exist on a scale that is a testament to Latin American governments’ failure to streamline formal business regulations.

In-Store Retail: Independent vs. Modern
Independent retailers continue to account for the majority of formal retail sales in Latin America, but modern retail has significantly changed purchasing patterns in large urban areas. This is especially true in fast moving consumer goods such as grocery purchases. Latin American consumers have traditionally purchased meats, produce and packaged goods from different shops, requiring regular trips to multiple locations. Consumers are generally moving toward infrequent, large purchases at super/hypermarkets supplemented by frequent, smaller purchases at independent stores. The leverage modern retail chains have with suppliers helps to drive down prices. This creates a difficult environment for independent retailers but is an added benefit for consumers.

Traditional Values
Independent businesses still account for the majority of grocery sales in many countries, including Mexico (See Figure B), Argentina (See Figure C) and Colombia. Independent retailers have several competitive strengths: proximity, credit, the convenience of smaller size, and a personal touch. Importantly, they commonly extend credit to liquidity-constrained customers, allowing them to pay after they receive wages.

Because of low overhead costs, independent retailers do not have to serve a large consumer base. They are located where modern retailers have not ventured—rural areas and small cities—and fill in gaps around the footprint of modern stores in urban areas. In Mexico, for example, there are over 500,000 independent retailers compared to 587 hypermarkets and 657 modern supermarkets. For households without cars, the local independent grocer is typically the only real option for daily purchases even though some might make weekly shopping trips to modern retailers by taxi or public transportation.

Not only are independent stores in closer proximity to the consumer, but less time is usually required to locate and purchase the items once inside the store. For these reasons, impulse purchase goods continue to favor independent retailers. In Mexico, family-owned stores account for a little over 50% of total retail sales compared to 80% of carbonated beverage sales (McKinsey). The story repeats itself in Colombia, where independent retailers captured 95% of all retail beer sales.

In Mexico, 80% of all retail customers shop at an independent grocer at least once a week; however, independent retailers are losing ground to modern formats. In local currency terms, independent grocers saw sales shrink slightly from 2004 to 2006 while discounter, supermarket and hypermarket sales expanded 29%, 18% and 6% respectively. Consumers spend an average of Mx$215 (US$20) at a supermarket compared to Mx$35 (US$3.25) at the local grocer. The Mexican Center for Micro and Small Business Studies estimates that as many as 50 independent retailers close for every one new supermarket or hypermarket in the same urban area.

Independent retailers weathered the Argentine crisis better than any other category and reaped the benefits of recovery by increasing sales 130% from 2002 to 2006. Customers became extremely price-conscious and avoided modern retailers because of perceived higher prices. Modern retailers were severely constrained by a protective law passed during the crisis that limited the construction of new retail outlets based on size. Domestic chains like Coto halted expansion to focus on debt restructuring. French-owned Auchan finally pulled out in 2004 from complications arising from the crisis. Its stores were sold to Spain’s San Jose and most recently were acquired by Wal-Mart.

Modern Conveniences
Modern supermarkets offer consumers an alternative shopping experience marked by unprecedented brand selection, bulk pricing and a well-lit, climate-controlled shopping experience. Most importantly, consumers can save time by purchasing a wide range of goods under the same roof. Hypermarkets take the concept further by combining grocery and department store shopping. Discounters (club stores) were the last to arrive and have consequently grown swiftly in popularity in most markets, with CAGRs of 40% in Brazil, nearly 18% in Argentina and 30% in Colombia since 2001 thanks to rapid new store growth.

Brazil boasts a more mature modern retail sector due to a wave of market entry by modern retailers in the late 1990s, helping to create a 4% increase in total retail productivity per year afterwards (See Figure D). Hypermarkets are well-disseminated, hold the top position in sales for all retail categories and still grew at a faster rate than all other retailers in 2006; however, there is massive underreporting of cash sales by independent retailers in an effort to lower tax payments. Modern retail giants include Pão de Açúcar, Carrefour and Wal-Mart. Wal-Mart is investing the most aggressively to the tune of US$400 million in 2007. With a solid foothold in the A and B+ income segments, modern retailers are eyeing a largely untapped market: B- and C consumers who represent 53% of Brazilian households and 52% of food consumption.

Incomes are on the rise and studies suggest that the viable mass market share of consumption should increase from 48% in 2004 to 60% by 2009 (See Figure E). A recent survey found that 60% of added income for these Brazilian consumers would be devoted to better quality and higher quantity of food. The average consumer in the rest of the world comparatively spends 60% of any additional income on non-food items.

Modern retailers are responding with a segmented strategy. Pão de Açúcar acquired a line of heavily discounted supermarkets in Northeastern Brazil called CompreBem to target lower income consumers and another of the same ilk in Southeast Brazil named Barateiro, whose name was changed to CompreBem to form a national chain. Wal-Mart adopted a similar strategy with their Todo Dia stores. Carrefour not only began a discount supermarket, Dia, but allowed independent retailers to join the chain.

Mexican consumers prefer the larger forms of modern retail— hypermarkets and discounters—to supermarkets. Their combined sales were almost four times modern supermarket sales for 2006. Wal-Mart is the leading operator of hypermarkets in Mexico, accounting for 27% of all hypermarket sales. It is the last major foreign operator standing since Carrefour sold out to Mexico’s Chedraui in 2005.

Argentina is shifting back to modern retail, which currently accounts for 39% of consumer goods sales. Major players include Cencosud of Chile, Carrefour, the local conglomerate Coto, and Wal-Mart. Hypermarkets, supermarkets, and discount stores have extremely high penetration among the upper and middle classes, and they are trying to broaden their customer base.

Colombia is emerging as another significant retail market, anticipating an annual growth rate of 12% in sales this year (EIU). The top five modern retailers, including Carrefour and Casino, account for 37% of the total retail market (AT Kearney). Independent retailers hold a majority market share and earned a CAGR of 8% from 2001-2006 (faster than supermarkets at 5%) but were still outpaced by hypermarkets at 19% and discount stores at 29% (See Figure F).

Non-Store Retail
Non-store retail methods, such as home shopping (largely composed of infomercial and catalogue sales), direct sales and online retailers are also benefiting from rising disposable incomes in Latin America (See Figure G). The middle class in Latin America is growing in real and relative terms for the first time in 30 years and they represent the target market for direct sellers, the leading category within the non-store retail channel.

Home Shopping
Home shopping was never a strong channel in Latin America due to obstacles such as fraud, lack of credit and unreliable postal systems that made fulfillment challenging. Catalogue sales have grown very modestly in most of Latin America. Infomercials are, however, increasing in popularity with growing cable TV usage (See Figures H, I and J). In Argentina, they are regaining ground with recovered cable usage after the 2001 crisis. Mexicans spent Mx$1.5 billion (US$138.6 million) on infomercial purchases in 2005, but registered only 3% growth from the previous year. Home shopping’s share of total retail is declining due to rising penetration by modern retailers, internet shopping and direct sales. Internet retail has already surpassed home shopping in Chile and Brazil, and is expected to do so in Argentina and Mexico in 2007 or 2008.

Direct (Multi-level) Sales
Direct sellers in Latin America secured 28% of cosmetics/toiletry retail sales for 2006. This sales method is well-established in most countries and we forecast it to grow by 18% annually in 2007. Direct sales representatives in Latin America totaled 5.6 million individuals, of which 80% are women. Representatives can earn or supplement their income from home with flexible hours. They have access to rural and lower income consumers out of reach of modern retailers. Direct sales face less competition from internet sales than home shopping because of the loyal customer base and personal touch, not to mention the lack of internet penetration amongst SES C and D. Representatives not only distribute products but also provide personal beauty or health consultations for their customers.

Brazil’s direct sales increased 26% in 2005 alone, partly due to an influx of “Brazilian” cosmetic and ecopharmacy products with all natural domestic components. Natura Cosmeticos, positioning itself as progressive and environmentally sensitive, released 225 of these new products last year. High profile introductions include Diversa, with novel refillable packaging, and a unisex fragrance derived from essential oils. Natura has grown to be a regional player with direct sales operations in Mexico, Argentina, Chile, Peru, Venezuela and Colombia, challenging global heavyweights like Unilever, Avon, Estée Lauder and Mexico’s Jafra Cosmetics International.

Mexican direct sales reached Mx$33.4 billion (US$3 billion) in 2005, an 8% growth over the previous year. Vitamin and dietary products represent 11% of direct sales in Mexico.

In Argentina, direct sales companies had to rebuild their representative and customer bases after economic hardship forced many of them to seek alternative employment. Direct sales are forecast to grow proportionally with disposable income.

Internet Retail
B2C ecommerce is gradually emerging as a viable channel thanks to increased internet penetration in Latin America. Currently, 16% of the population has access to the internet. Among the region’s top five countries for internet usage, online retail was the fastest growing non-store retail category for 2000-2005 and is expected to hold the title through 2010. Visa Latin America alone registered US$2billion in B2C online transactions in 2005, an increase of 52% from the previous year. Total online credit card sales reached approximately US$7 billion by the end of 2006.

A favorable investment environment, combined with political and economic stability, is needed for steady internet growth so that investors can bet long-term on rolling out infrastructure to a wide market. Argentina had invested in internet infrastructure before the economic crisis in 2001 so internet usage grew rapidly during recovery; however, over half of current internet users are concentrated in Buenos Aires. Colombia still has low internet penetration, reaching only 13.2% in 2006. Chile, the most economically stable performer over the past decade, also has the highest internet penetration (See Figue K). Online sales are forecasted to surpass direct sales by 2009.

Online sales have been concentrated in the areas of travel, electronics and downloadable media, much like the US internet retail market in the 1990s. Products that are digitally transferred (air plane tickets, music, software) do not face the delivery challenges of physical goods. Stores keep very low stock on IT products, so their consumers often purchase them online. Recently, categories like government services and education have seen increased online transactions. Consumers have greater confidence in the security of online transactions because of measures taken by the government, financial institutions and electronic payment systems. Low credit card penetration has constrained B2C internet sales in many countries like Columbia and Mexico; however, credit levels are growing by over 20% annually across Latin America according to our estimates, and will prove less of a constraint in the future. Going forward, the biggest impediment to B2C internet sales will be limited in-home computer penetration. In 2004, only 17.4% of Mexican households owned a computer.

The Informal Market
The informal market is, by nature, hard to quantify. According to a McKinsey study in 2007, the informal economy across Latin America represents 38% of the region’s true GDP. In the retail, one of the most visible segments of the sector, informal channels represent about 50% of all retail sales.

The informal economy is defined by the International Labor Organization as “all economic activities by workers and economic units that are—in law or in practice—not covered or insufficiently covered by formal arrangements.” This includes unregulated selfemployment, employment and business enterprises (See Figure L). Avoiding formal regulations affords these individuals and businesses higher earnings (at least in the short-term), but it also creates low-cost (some would say unfair) competition in the market.

The main reason informal retail channels thrive in Latin America is the overbearing presence of government in the formal sector. It is fair criticism to say that too many segments of government in Latin America do not exist to facilitate business but are there to tax it and complicate it, creating revenue and opportunities for graft in the process. Most entrepreneurs in Latin America cannot afford to comply with all the rules set by government and eventually drive their businesses into the informal sector.

Brazil is a shining example of wasteful governmental interference in the formal economy. Registering a new business in Brazil takes on average 152 days, versus three days in the USA. A typical business in Sao Paulo must report seven different taxes four times per year. The present economic boom in Brazil is creating record employment growth. Unfortunately, an estimated 93% of new jobs are created in the informal sector.

Brazil’s formal private sector jobs are concentrated in the large companies that make up its industrial sector. Those companies are not fairing well as the overheated real makes their export sales uncompetitive. Meanwhile, the government must spend more to build infrastructure for its expanding economy but its formal sector tax base is failing to grow, forcing them to consider even higher taxes. The vicious cycle continues.

Unemployment and underemployment make the informal sector attractive to many Latin Americans. The region faced a formal employment deficit of 126 million jobs in 2006. With birth rates beginning to drop in the late 1980s, most Latin American markets have a demographic bulge in the 15-25 year old age segment, precisely when people are looking for their first job. Not surprisingly, unemployment in that segment is 2-3 times higher than older age brackets. These young workers gravitate to the informal sector and dominate its numbers.

The region’s restrictive labor laws, which add to the cost of hiring, employing and especially firing, make companies reticent to hire young, unproven employees and lengthen the process of finding new employment for any age group (See Figure M). Argentina’s labor flexibility is among the 20 lowest in the world. Displacement as a result of political violence has compounded the problem in Colombia. The country’s National Administrative Department of Statistics estimates that 53% of the workers in Bogotá are in the informal sector. Retail is the sector’s largest category and comprises 33.5% of all informal economic activity.

Informality is also fueled by mass urban migration in countries like Brazil and Mexico. Street commerce is one of the most visible and dynamic segments of the informal economy. Industry sources suggest that there is one street vendor for every 85 people in Mexico City and that many arrive on the street scene after the close of their independent grocery store. São Paulo is home to 10% of Brazil’s total population and, of the economically active, 11% are street vendors. This enormous percentage reflects the huge compliance and operation costs of Brazilian retailing that are especially damaging to micro-enterprise.

Governments have made strides to regulate street vendors in certain urban areas with moderate success. Vendors are usually affiliated with trade associations that band together to create substantial political power. In São Paulo alone there are 770 street vendor associations. This makes it easy for the government to communicate with street vendors but difficult for it to enforce regulations because these politically organized groups can push back against zealous government tax policy makers.

Brazil’s massive informal economy comprises 42% of GDP. Approximately 55% of the workforce is in the informal sector. Informal retailers are part of a truly global network. Higher-end products like electronics, jewelry, and clothing are manufactured in China, enter Brazil illegally through Paraguay, and are distributed to informal retailers throughout the country. By avoiding Brazil’s notorious tariffs and taxes, these retailers can offer prices that no formal retailer can match.

Consumer goods manufacturers can move their products into this channel through club stores and cash-and-carry wholesalers. Informal vendors often buy their goods from modern retailers as opposed to independent wholesalers to take advantage of bulk pricing. Sam’s Clubs are challenging cash-and-carry wholesalers in some areas. Street vendors of food often buy their supplies from hypermarkets or club stores to save money, especially if the location of those stores is convenient.

The one great threat to the informal sector is the proliferation of consumer credit through greater credit card circulation. As more middle class consumers acquire their first credit card, they will be tempted to buy white goods, electronics, even clothing from formal retailers that accept their cards, enabling them to space out their spending over time. The combination of credit and more efficient hypermarkets in Chile and Mexico has already shown evidence of this trend as the informal market loses some of its share of the higher value products that can be challenging to finance in one single cash payment.

However, the dent in informal sales in Chile and Mexico is just that - a small dent. The informal chain will reign supreme as long as Asian products remain subject to high import tariffs, VAT levels remain high and the greedy and inefficient hand of government continues to meddle with formal retailers.

Channel Strategy
Channel priorities change from product to product and may vary by market depending upon the penetration of modern sales channels. However, broadly speaking, the chart provides (see Figure N) some guidance as to where marketers should be focusing their sales efforts.

InfoAmericas (www.infoamericas.com) has three base offices, in Coral Gables, FL, Mexico City, Mexico and Sao Paulo, Brazil. Founded in 1993, the research firm helps companies develop solid business intelligence for implementing successful market strategies across Latin America and the Caribbean. This article was written by Evette Treewater, an InfoAmericas consultant and John Price, the company’s president.
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