retail sector in brazil: riding the wave of middle class growth and

Fast Facts

Brazil is the fifth largest country in the world and thelargest Latin American economy.

The Economist Intelligence Unit had forecasted thatBrazil will overtake the U.K. to become the sixth-largest economy in 2011.

Brazil is the biggest exporter of iron ore and the largestexporter of meat, coffee, and chicken.

Brazil is the fifth most populated country in the world

Over the last two decades, thanks largely to welfare

schemes launched by the government, the poverty rate

has halved in Brazil.

Income equality in the country has also fallen sharply,

declining on average by 1.2% a year.

The Brazilian retail market is worth about $230 billion.

More than 30 million Brazilians have risen out ofpoverty since 2003 to create a new middle class.

Demographics also favor the growth of the consumer-

oriented sectors of the economy. About 80% of the

country’s 190 million population lives in urban areas.

_____________________________________________________________________________

Even in the late 1990s, Brazil

was just like any other emerging

economy, characterized by

extremes of wealth and abject

poverty with no social class

dividing the bridge between. A

decade and more down the line,

the effervescence in the middle

cannot be missed. Yes, the great

Brazilian middle class – defined

as those who earn between $690

and $2,970 a month – has arrived

and is here to stay. If Brazil has

made a name in the global retail

sector, it had better thank these

late comers, empowered with

good purchasing power and

access to credit.

Retail Sector in Brazil: Riding the Wave of Middle

Class Growth and Consumer Credit Boom

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Of course, the commodities powerhouse has benefited from the high prices of iron ore spurred by

China’s voracious appetite. But what makes the Brazilian success saga stand out is that some

shrewd social engineering by some of the country’s visionary leaders ensured that the

commodities wealth trickled down to the poorest sections of society. To put things in

perspective, the so-called middle class, who comprised some 38% of the country’s population in

2001, currently accounts for a whopping 55%. Social welfare schemes such as the Bolsa Familia

implemented by former president Lula da Silva after he took over in 2003 also ensured that in

addition to benefiting from liberal handouts, low-income families also received the golden

opportunity to educate their children, which made a real difference in their lives. The scorching

growth of the domestic retail sector over the course of the last decade or so, triggered by the

emerging middle class, also has something to do with the country’s demographics. Economists

have pointed out that about 80% of Brazil’s population of 190 million lives in urban areas.

Global Retail Development Index

Country 2011 Rank 2010 Rank

Brazil 1 5

Uruguay 2 8

Chile 3 6

India 4 3

Kuwait 5 2

China 6 1

Saudi Arabia 7 4

Peru 8 9

U.A.E. 9 7

Source: A.T. Kearney

Hyperinflation and its aftermath

By the mid-1990s, international retailers woke up to the fact that developed markets had reached

a point of saturation and offered little scope for further expansion. Quite naturally, their eyes fell

on the newly emerging markets, especially those Eastern European nations that had come out

from behind the Iron Curtain around the same time. Despite the shift in the retailers’ mindset

during the decade, due to a number of economic issues Latin America did not figure on their

radar screens until toward the end of the 1990s.To begin with, South American markets as a

whole were characterized by economic instability. High levels of public debt and hyperinflation

were the hallmarks of many Latin American economies and Brazil was no exception. To put

things in perspective, inflation in Brazil had touched a mind-boggling 5000% in 1994. This

daunting inflation scenario worked to the detriment of both consumers and retailers alike. If

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buyers were forced to make purchases soon after they received salaries for fear of losing the real

value of their money, retailers too had to revise their price lists frequently. To sum up, the

economic situation was not encouraging for retailers as they tried to gain a toehold in the

domestic sector.

Thankfully, the situation changed for the better under Fernando Cardoso, the visionary leader

who was the president of Brazil from 1995 to 2002. Cardoso launched what has come to be

known as the Real Plan, which introduced a new Brazilian currency. The Plan, which was

nothing short of a shock treatment for the economy, also helped tame inflation. The initiative

unleashed a generation of consumers who for years had been fettered by high inflation. Granting

the central bank operational independence in 1999 also helped, with the bank setting its inflation

target at a slightly variable 4.5% beginning in 2005. Brazil was lucky to have an equally

competent successor to Cardoso in Lula da Silva who assumed office in 2003. In addition to

family welfare schemes, Lula’s programs included subsidized housing, an easier access to credit,

and generous pay hikes, among other initiatives. Consumer lending was boosted as banks were

allowed to deduct interest charges on debt directly from the workers’ payroll. According to a

study by Brazil’s Getulio Vargas Foundation quoted in the Financial Times, about 49 million

low-income Brazilians rose to the ranks of the middle and upper-middle classes since 2003.

Meanwhile, China’s role in the emerging market story was playing out well in the background,

with the Asian economy eclipsing the United States as Brazil’s largest trading partner. The

current incumbent Dilma Rousseff expanded the scope of the good work initiated by her

predecessors, boding well for consumers and industries alike. With this, the stage was set for

consumer-oriented sectors such as retail to train their guns on the Brazilian market.

Consumer Credit in Brazil

Commodity boom and social welfare schemes apart, another factor which favored the growth of

the retail sector in Brazil was the opening up of the credit market around 2005. Still, as recently

as 2004, growth in consumer lending was virtually non-existent in Brazil due to exorbitantly

high interest rates. Lack of competition in the domestic banking sector and taxes on credit

pushed up interest rates. According to the Central Bank of Brazil, the credit market in the

country now constitutes almost 50% of its GDP. The benchmark Selic rate, which had touched

26.5% in 2003, now stands at 11.5%, also encouraging lending. Here again, the government was

the prime mover as it rolled out payroll loans that were first offered to pensioners and public

sector workers. The scheme, which deducted interest straight from salaries, was a big hit,

especially with the senior citizens of Brazil. The second stage in consumer lending was the

issuance of credit cards, particularly co-branded cards issued by banks in agreement with retail

chains. Itau Unibanco tied up with Pao de Acucar, while Bradesco’s partner was department

store Casas Bahia.

Besides the availability of credit, which was a big boost to the growth of the retail sector in the

country, a typical Brazilian shopping t

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5

Types of Credit

DIRECT CONSUMER CREDIT (CDC)

Direct Consumer Credit (CDC) was one of the earliest consumer finance products to be launched

in Brazil. Under this system, consumers purchase goods in installments through bank orders or

pre-dated bank checks. This form of credit, which mostly works in arrangement with retailers,

has been usurped by credit cards in recent times. HSBC’s consumer finance unit Losango, which

has been put up for sale, follows this business model.

PAYROLL LOANS

Under this system, payments are deducted from the borrower’s pay check itself. Payroll loans are

considered less risky to lenders as credit is given against payroll guarantees. This form of credit

benefits consumers too, as interest rates tend to be lower than the direct credit offered by

retailers.

CREDIT CARDS

Over the years, credit card transactions have become the favored buying instrument for

Brazilians. The credit card processing segment in Brazil is valued at about $420 billion a year,

with Reuters reporting that there are more than 630 million outstanding credit cards in Brazil.

Home-grown credit card processors Cielo and RedeCard have a vise-like grip on the industry,

while the likes of Visa, MasterCard, and Citibank’s Credicard unit have big plans chalked out for

the Brazilian market.

Retail segment in Brazil

Although organized retail in Brazil could be traced back to 1948 when the current market leader

Companhia Brasileira de Distribuicao (CBD), better known as Pao de Acucar, started off as a

small bakery, the last decade witnessed hectic activity in the sector. Among foreign-owned

entities, French retailer Carrefour S.A. was among the early birds to set up shop in Brazil,

coming in as early as 1975. Walmart Brazil, the third in the pecking order, was established in

1995. However, the deep-pocketed foreign players would soon realize that the Brazilian market

was a different kettle of fish when it came to consumer behavior patterns. In contrast, home-

grown retailers such as Hypermarcas and apparel retailer Lojas Renner S.A. have continued to

grow at faster rates, helped by their knowledge of the local market.

Brazil became a hot destination for investors since it found a place for itself in the now famous

BRIC group of emerging economies. While some of Brazil’s bigger counterparts ran for cover

during the financial crisis of 2008-09, the Latin American economy managed to keep its head

above water, thanks to the consumption potential of its people. Of course, various stimulus

6

packages rolled out by the government also put more money in the hands of consumers.

Brazil’s retail market is estimated to be worth about $230 billion, driven mostly by domestic

demand. Besides the 40% growth in GDP per capita during the last eight years or so, population

distribution also plays a vital role in encouraging the growth of sectors such as retail. About 30%

of the country’s population lives in the 10 principal metropolitan cities. Sao Paulo brims over

with a population of 18 million, while Rio de Janeiro has 10 million.

Still, the consumption habits of this predominantly urban population are diverse. As a PwC

report points out, the lower income sections tend to spend more on essentials such as food and

beverages, while those in the upper income bracket splurge on leisure, durable goods, as well as

luxury items. The Brazilian market is also perhaps the most internationalized among the BRICs,

as the top 10 retailers corner almost 60% market share among themselves. Food retailers, apparel

retailers, consumer goods makers, appliance retailers, and consumer staples companies form the

backbone of the sector.

Major Players

Brazil has emerged as the world’s third-biggest grocery market, next only to America and China,

thanks to the aggressive growth strategy adopted by players operating in the market, both foreign

and domestic. Global retailers such as Walmart and France’s Carrefour bank on the Brazilian

market to make up for sagging sales elsewhere. At the same time, domestic market leaders such

as Pao de Acucar give them a run for their money. Still, the new entrants find it tough to gain a

foothold in the highly competitive market, which offers great potential for growth.

Top Retail Firms in Brazil

Company OwnershipMarket Cap inBillions (USD)

Pao de Acucar Public 10.9

Carrefour S.A. Public NA

Walmart Brasil Public NA

Lojas Americanas Public 7.2

Lojas Renner Public 4.1

CIA Hering Public 3.9

Hypermarcas Public 3.8

Raia Drogasil Public 2.7

Lojas Marisa Public 2.1

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GRUPO PAO DE ACUCAR

Pao de Acucar is by far the biggest diversified retailer in Brazil, selling everything from

groceries to home appliances to clothing. The company, which has a market share of about 18%,

has made strides under the stewardship of Abilio Diniz. The company’s foray into the sale of

home appliances has been spurred by the acquisitions of the Globex Utilidades SA’s Ponto Frio

chain as well as the Casas Bahia outlets. The retailer operates under brand names such as Pao de

Acucar, Sendas, Extra, CompreBem, and Extra Eletro.

CARREFOUR S.A.

The French retailer, second only to Walmart worldwide, has been a significant market presence

in Brazil for more than 25 years with a market share of about 14.5%. Brazil figures prominently

in the diversified retailer’s game plan after its hypermarket format failed to click and European

sales tumbled. However, Carrefour’s attempt to combine itself with Pao de Acucar last year had

to be abandoned after a major shareholder in the Brazilian market leader objected to the deal.

WAL-MART BRAZIL

Though the world’s largest retailer took some time to become established in the country, its

Brazilian unit is now one among its best performing subsidiaries. Last year, Walmart Brazil,

which has a market share of 12%, created ripples in the market when it implemented its

“Everyday Low Prices” strategy to take on its rivals. Though Walmart Brazil first entered the

market through a joint venture with local player Lojas Americanas, its growth has been driven by

acquisitions of the local units of Netherlands’ Royal Ahold and Portugal’s Sonae.

Apparel Retailers

Unlike the retail grocery and household appliance market, local and traditional brands dominate

the apparel and fashion sector in Brazil, the world’s fifth largest apparel marketplace. With more

than 60% of the country’s population below the age of 29, the apparel market has been growing

at a rate of 7% a year, according to a McKinsey Quarterly Report published in July 2011.

Fashion-conscious Brazilians are heavily swayed by clothing lines endorsed by local celebrities.

Moreover, unlike in other emerging market, they tend to purchase apparel on credit more

frequently.

LOJAS AMERICANAS

Founded in 1929 by four Americans, the discount retailer sells clothing lines, toys, household

goods, small household appliances, chocolates and candies, as well as CDs and DVDs. Lojas

also has a presence in the online retail space under the brand B2W Varejo.

8

LOJAS RENNER S.A.

This discount clothing retailer’s clientele is comprised primarily of young females, with the

company clocking 60% of its sales revenues through credit. American department store chain

J.C. Penney had a controlling stake in Lojas, which it divested later.

COMPANHIA HERING (CIA HERING)

Still owned by the founding Hering family, CIA Hering is easily the oldest home-based textile

and clothing maker. In recent times, the retailer has focused on opening stores in tier 2 Brazilian

cities aimed at the newly emerging middle class who have access to credit.

Outside the conventional retail space, the likes of pharmaceutical goods and personal hygiene

products maker HYPERMARCAS and cosmetics products maker NATURA COSMETICOS S.A. also have

carved a niche for themselves in the Brazilian market. Amid these big home-grown players,

footwear chain ARREZO, drugstore RAIA DROGASIL, and home appliances retailer MAGAZINE LUIZA too

have managed to create a shelf space for themselves.

The mega deal that never materialized

It all began in June 2011 when Carrefour publically announced that it received a proposal to

combine its Brazilian operations with those of Pao de Acucar. Under the terms of the deal, both

Acucar and Carrefour Brazil were supposed to merge into Gama, a holding company funded by

the government-owned Brazilian National Development Bank (BNDES). The combined entity,

as The Economist pointed out, would have had sales of $43 billion or a 21% share in the fast-

growing retail market. The deal would have no doubt benefited both the sides, but for the

objections of Casino, a French retailer which holds a 37% stake in Acucar. Expectedly, Casino

cried foul, terming the deal illegal. The stand-off also strained Acucar-Casino ties, according to

media reports from Reuters. Although the business proposal had the implicit blessings of

Brazilian policy makers eager to create true national champions in fast-growing sectors such as

retail, the deal ultimately had to be shelved.

Store Formats

As pointed out by a July 2011 McKinsey Quarterly Report on the retail sector, Brazilian

shoppers stand out for some unique behavioral patterns. First of all, shopping for them is a

relaxing, everyday activity where they expect salesmen at the counter to treat them royally. Most

shoppers, the report observes, would like to travel to the stores by foot, which means they prefer

retail shops located closer to their homes. Another marked trait of the domestic shopper, the

study shows, is that he or she is extremely price-conscious compared to their peers in India,

China, and Russia. Keeping these trends in mind, Brazilian retailers have devised a variety of

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store formats to reach out to this lucrative consumer. Rather than focusing on a particular format,

these ambitious players have pursued a multi-pronged approach which includes neighborhood

supermarkets, hypermarkets, convenience stores, discount stores, and online stores.

Supermarkets

Supermarkets, the typically large modern-day self-service grocery stores, tend to dominate the

segment, accounting for 80% of purchases made. Leading players such as GrupoPao de Acucar,

Wal-Mart, and Carrefour all follow this format.

Hypermarkets

The hypermarket format, a superstore which combines a supermarket and a department store, is

also very well entrenched in the Brazilian retail market. Carrefour, for instance, makes three

quarters of its sales from its hypermarkets, in addition to its other store formats such as

supermarkets, cash&carry, and convenience stores.

Convenience Stores (Hybrid Indigenous format)

Big retailers were quick to realize that the “one-size fits all” model could not be applied to the

Brazilian market. Thus, retailers operating in Brazil adopted the concept of the convenience

store, mostly located in gas stations, to augment the traditional retail format.

E-Commerce

According to Euromonitor International, Brazilian Internet retailing has shown impressive

growth in recent years. The report points out that increasing access to broadband and falling

prices of personal computers have driven the upsurge. E-commerce has increasingly expanded

beyond traditional economic hubs like Sao Paulo, as lower-income groups join the Internet

bandwagon. Encouragingly, women, who have traditionally lagged men in making purchases

online, now make up 50% of web shoppers in Brazil.

The road ahead for retail

Still, the Brazilian juggernaut would do well to realize that it may not be wise to bank solely on

fluctuating commodity prices and an overstretched consumer in its march forward. Beneath the

glitz and glamor of Brazil’s shopping aisles lurk some issues that are common to many emerging

markets, such as rampant inflation, hot capital inflows, and poverty, among other factors. First,

the country, through its education system, will likely need to focus on training a future workforce

to support the burgeoning retail industry. Poor infrastructure, the bane of the Brazilian retail

industry for years, is also a concern, although preparations for the 2014 soccer World Cup and

2016 Olympics are expected to go a long way to address the need. Although sectors such as

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natural resources and banking are dominated by what is known as state capitalism, where the

government exerts control of strategically important companies, notably Brazil’s retail industry

has remained more or less independent. Still, corruption and bureaucratic red tape hamper the

development of the retail sector and, as media reports point out, big foreign players find it

difficult to navigate the byzantine ways of Brazilian bureaucracy.

Many analysts are alarmed over Brazil’s rapid credit growth, fearing that a U.S.-model credit

bubble may be brewing. However, as a Financial Times report pointed out, this concern may be

unfounded as about 60% of consumer loans are made against payrolls, property, or cars and are

offered at fixed rates.

To sum up, the Brazilian retail success story should be understood in the wider context of the rise

of its middle class as is the case with many emerging markets. Yet, unlike in other developing

markets, deep-pocketed multi-nationals such as Wal-Mart and Carrefour have tasted

unprecedented success in the retail sector. Amid the unraveling Euro-zone crisis and slowing

global growth, Brazil, despite all its shortcomings, may yet prove to be an oasis of growth for

global retailers.

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retail sector in brazil: riding the wave of middle class growth and

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