Brazil: Paradoxo Brasileiro: Is High Import Tax Driving More Geographically Diverse FDI Into Brazil?

Last Updated: 14 May 2014
Article by David Kerr

TMF Group's retail expert says the opportunities in Brazil's second and third tier cities are only just beginning.

World Cup 2014. Rio 2016. Hundreds of reports of vast opportunities for growth. Brazil is exciting - it's been exciting for the past 10 years. So long, in fact, that fashion retailers may fear they've missed the boat for claiming market share and gaining recognition in Brazil if they're not already there.

Fortunately it seems you have no need to panic.

Strangely, with all the infrastructure investment catering for the pending global sporting spectacles, retail growth in Sao Paulo and Rio de Janiero has reduced to the low single digits and is forecast to be between 1.8 and 2.5% over the next two years.

Much as the banks of the Amazon offer sustainable and fertile ground for growth throughout the country, Brazil's  second and third tier cities are proving equally fruitful for businesses, and will eventually accommodate more than 75% of Brazil's middle class consumers by 2020.

While the levels of government expenditure are incomparable, it still bears similarity to the size of opportunity in China 10 years ago in cities such as Guangzhou, Qingdao, Tianjin and Chengdu. According to BCG, companies will require a substantially greater geographic presence in Brazil in order to achieve long-term sustainable growth. To put things in perspective, to touch the entire population, you would need to be present in 405 cities.

Talking specifically to the retail market in Sao Paulo and Rio, high import taxes on apparel and footwear (up to 35% for some products) continue to drive wealthy consumers to travel abroad to mainland United States, London or Paris.  But consumers demanding access to foreign fashion products in places such as Manaus and Porto Alegreare more than 1,000 miles from the nearest international airport and so such international consumerism is not viable. These consumers are now accepting to pay the premium created by the tax in exchange for the convenience. This reluctance to travel means that retailers need to be on the high streets and in the shopping malls of these cities.

TMF Group's work in the real estate investment sector enforces this point of view: the end of 2013 and Q1 2014 has seen us involved and in discussions on a number commercial real estate projects in Brazil's second-tier cities. Through these investments, the infrastructure will be or indeed is now in place for retailers to set up and start to access these untapped markets.

The main challenges and questions for retailers therefore are around talent, cultural agility and appreciation and compliance. According to our benchmark complexity study, Brazil is ranked 17th in the world in terms complexity.

The dilemma for a CFO or General Counsel is, assuming you have managed to set up a legal entity in Sao Paulo, what type of entity should follow in Buzios or Ribeirao Preto as a subsidiary? How do you ensure your HR policy is compliant and that payroll, expenses and food vouchers are acceptable in Porto de Galinhas?  Which taxes are applicable to be registered for and how will you manage local accounting in Trancoso?

Fundamentally the question that needs to be solved is how you manage disparate operations and brand quality control in a country that is still in transition when it comes to being conducive to efficient and cost-effective retail operations. A quick start and compliant solution is paramount.

recent BOF article refers to "a silent movement" happening in Brazil: "Now we have to seriously consider other emerging cities and regions around the country." It also quotes Daniela Falcao as saying:  "Recife, Brasilia, Belo Herizonte, Curitiba and Ribeirao Preto are the most important markets for fashion outside of Sao Paulo and Rio. All the major cities of Brazil have undergone huge transformations in the past five to ten years."

This is not breaking news but clearly an affirmation that Brazil continues to offer the growth opportunities that we all saw and some benefited from for the past decade.

The challenge is going to be getting location selection, talent management, a go-to-market strategy and compliance right the first time and in parallel with one another. Stealing the march on the competition in these tier-two cities will create more brand loyalty with the emerging Brazilian middle-class and sustainability of success. The growth is there; we just need to work together to uncover it.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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