Latin America: Weathering the Storm
White Papers | February, 2016
By Larry Rubin
Economic and political uncertainties throughout Latin America have shaken the confidence and altered the outlook of those doing business there, or those who were considering the region for investment or expansion. The region’s GDP fell from a 0.4% increase in Q1 2015 to a 0.2% decrease in Q4 2015, according to FocusEconomics.
Further complicating the landscape is that the political and economic disruptions vary from country to country.
The presidential election in Argentina reflects the public’s fatigue with the political mismanagement that has driven the economy to the brink of crisis, and the new government faces a formidable challenge in re-establishing stability. Impeachment proceedings in Brazil are expected to halt fiscal reform and the economic outlook is expected to deteriorate along with it. And although the elections in Venezuela have clearly indicated the public’s thirst for responsible macroeconomic stabilization the overall situation remains dire and has, in fact, taken a significant turn for the worse.
The outsized impact of these three countries, the largest in Latin America, casts a shadow on other Latin American countries with smaller economies that are stable and, in some instances, improving.
The Pacific Alliance, Chile, Colombia, Mexico and Peru, though impacted by regional and global factors, are nevertheless expected to expand somewhat.
The challenges facing business leaders include how to weather the upheavals within the larger economies in order to return to maximum profitability once stability returns. There are opportunities in the smaller, but relatively stable, economies, but how to capitalize on them?
CEOs involved in these regions spoke on these topics with DHR to offer insights and advice that will influence decision making, establish realistic parameters and drive expectations based on viable objectives. Those CEOs were George Calienes, CEO, Latin America Daikin Applied; Arnaud Naintre, CEO, Sisley; and Carlos Said, CEO, Latin America Somfy.
Let’s Talk About Latin America
DHR: In 2008 the world collapsed and Latin America didn't. Latin America was a great place to be. Today, it's the exact opposite. What is corporate America’s perspective in handling this? Are management teams prepared to face rapidly evolving changes, and what are the key focus areas in the coming 18 to 24 months that you see your respective companies going forward in this environment?
Carlos Said, CEO, Latin America Somfy: We acquired several companies in Brazil in 2012 and 2013 and one in Mexico. One month ago we were targeting an acquisition from one of our competitors. We visited the company in Brazil. Five hundred million Brazilian dollars in revenue, which I would say is $150 billion [US dollars] in revenue, very profitable. Audited by Ernst and Young, a family business, well-regulated, professionalized. The goal of the company was to be acquired within their industry. We left the company very happy. The CEO of the company reported to the shareholders and just three days after the deal was essentially done. Then, the CEO of Somfy went to the board of directors and, based on the meeting that we had one month ago, asked if he had the green light to move forward, and the decision from the board was no green light for Brazil.
DHR: Regardless of what the company was?
Said: No green light. And, by the way, the major competitive advantage that we had was that we could have this company for €100 million, when a few years ago it was €250 million. Not because of the economy but because of the political situation. That is what is effecting the economy more. For acquisitions, for investments, it's the political situation in Latin America. The day-by-day political situation affects the economy. So, no green light for Brazil. Red light.
Somfy is a French company, very traditional, they take some risks but not so much. They've acquired companies in China, but no green light for Brazil. We found a golden company to be acquired that was a bargain at €100 million, but they said no.
DHR: And that's a transaction five years ago would have been done in two seconds?
Said: In Latin America, you weigh and balance from country to country. Because in some countries you can cut costs, in others develop new lines of business for the corporation. In Latin America you may have revenue of $1.9 million [US dollars], a profit of 9%, but no money is going to Brazil, for the protection of Wall Street. Mexico may have the volume and the revenue and the stability, today, and small countries like Paraguay, Guatemala, may give you the lack of political instability, but with countries like Argentina and Brazil you don't know what the future is, even in the short term. You have to think very carefully about your plan.
DHR: Inflation is going to be recognized for what it is, unemployment is going to be recognized for what it is.
Said: The numbers. Employment, inflation, the currency rate. In Argentina, or Latin America next year? As a general manager you must make one intermediate plan to Wall Street standards and you have to prepare for the worst. Inflation at 40%, unemployment and demonstrations. A lot of companies lost investments because the banks ceased operations. It's a different environment. What's going on this year, in Brazil, you have the banks and industry, a certain element of service provider, cutting costs.
DHR: How is the corporation taking this? When you have to deal with the senior levels of a corporation and explain all of this variety, what is the reaction?
Said: First, they don't understand. Americans say "Explain to me what is going on." At the end they understand that you must go through cycles. Argentina has cycles every 10 to 15 years, and that is the cycle. Companies say "OK, we're not looking for the short term, we're looking for 5 to 10 years." And Somfy has 150 years investing in other countries and their economies. They trust that you understand what is going on in your countries.
Arnaud Naintre, CEO, Sisley: In industries that I’ve been involved in, with Cartier and premium retail and beauty, the situation is global in the sense of the decrease in sales.
DHR: Latin America is not a growing area. It’s a gray, emerging market.
Naintre: In this industry we get less of a bad rap. We get a free pass, almost, because globally the industry is suffering, in the case of Cartier and watches and jewelry. In the case of beauty, not as much, but still. Right now, to your second point, it’s a matter of maintaining the business footprint that you have but, more than that, being ready and studying the retail offer as far as real estate in the countries that will become the countries that they should. For example, Argentina, should come back. As the place of business that was good for premium, sadly, Venezuela is far from it, but it would be our third market, and Mexico is doing okay. I think that it’s a time of patience, of presenting flat figures in consolidated and, as far as a per country situation, they really don’t care. They absolutely don’t care. Consolidated, to the point earlier about Brazil.
It’s funny, because it is a double edged sword sometimes. We love it because Brazil gets put into the basket and it saves us, but now it’s not…Mexico is helping out, now. Brazil used to help out, but now…
DHR: One of the industries seemingly isolated from this crisis in Latin America, especially Brazil, is luxury brands like Louis Vuitton, Cartier. Brazilians are traveling less so they are investing internally, in these luxury brands, so the person that would buy Louis Vuitton is not traveling to buy it in New York, they are buying in Brazil.
Naintre: About a month ago premium products were cheaper in Brazil than in New York. And Rolex, for example, just before the devaluation said that they would keep their worldwide pricing consistent. But everybody else took advantage and got rid of stock, because the Swiss watch industry is really in a purging year. Overstocked. They used that situation to simply unload, little by little. And in the months that come there will have been some price adjustments, but no regional director or country manager wants to rush to it, but it is happening. You are right, and not only in Brazil, but for China, as well.
I’ve been asked to study the retail landscape, especially the mall situation. What is available? What is the best? Being very scientific with the metrics, the KPIs of what is available, to be ready, to make the right decisions for 2017, really because 2016, as you know, regardless of Argentina’s elections, premium products are looking at Argentina closely.
DHR: Real estate, in Brazil, in particular, was very expensive, but now it’s very cheap. A lot of the large funds, the Brookfields, the Black Waters, the Blackstones, are looking into it but not many transactions have happened.
Calienes, CEO, Latin America Daikin Applied: Fortunately, I don’t have to worry about Brazil and Argentina, but we are really tied to the construction industry, and for us it’s not so much the foreign-exchange drop, as the volatility. You start a project two years out, you design, you specify, you budget, and you start building and then, all of a sudden, you’re short 20% on what you had budgeted. What happens, historically, is that companies wait. They are waiting for the tip, or they are waiting for their currency to devalue to some degree to convert to dollars and some of the more sophisticated customers hedge in US dominated accounts, but we see a lot of issues. Colombia devalued 30%. We had projects that were ready to book that have been delayed for six months and are now coming back. If the evaluation of the currency is stable the market knows how to react, they find a way to go through and get projects executed. It’s when there’s uncertainty, when it fluctuates up and down dramatically, is when it really affects our business. Our business is actually doing very well. Year to date we’re probably 27% higher than the prior year, in dollars.
DHR: In the same markets?
Calienes: In the same markets, excluding Brazil and Argentina. We are an emerging group within the division, so we have a strong base, but we have had compound average growth rate of over 20% the last 10 years, so we’ve been growing at a healthy clip. Why? I think we’re doing things well and our competitors self-destruct, which helps you. You have to have the perfect strategy when your competitors help you. It’s kind of trying to go forward, faster. But, we are definitely seeing – Carlos mentioned in the small countries - Nicaragua, Honduras, Guatemala, Costa Rica - very small markets but we are seeing very significant projects. And our experience has been that you have to be everywhere, because, even a small country like Honduras, where they may only do one shopping mall a year, but it may be a $2 million project which, is for us, is significant.
DHR: Are there specific verticals? Are you seeking any specific industries that are growing faster?
Calienes: Yes. With the lower prices and the lower exchange rates you also have lower labor rates on the services side, so we are really seeing a return to manufacturing. Mexico is a perfect example. Toyota, Mazda, Honda and Nissan are building billions of dollars’ worth of factories, and then you have tier 1, tier 2 suppliers that come with it. The gravitational pull of that is huge. Mexico is going to be the manufacturing base for the automotive industry for the Americas, and they will continue to go that way.
DHR: What about in Central America?
Calienes: A lot of that went away. We don't see specific trends. We do see, for example, the health sector growing. Up until this year we’ve seen a lot of expansion on the retail side, and, similarly we see a lot of long-term plans for further expansion throughout Latin America. I think that they have narrowed their scope a little bit in terms of making huge acquisitions.
DHR: The projects being built, the oil industry, the gas industry and the mining industry, are down. There's no boom, anywhere. So, what are the key factors going into your success in an absolute market that is decreasing?
Calienes: There has been a paradigm shift in the market. We have been a very established player for 50 years where the pillars of industries, whether they gave you good service or bad, that's what you got. We've been there for 50 years providing an alternative with a higher level of service, a return to the past in terms of relationships, standing behind a dealer structure and creating an affinity for the brand and the company. We consider ourselves a premium brand in our sector, though you have four or five brands, so who you support and how to structure and position has become very convoluted.
DHR: Are the third tier brands really competing against you, or do they tear at each other while you stay above the fray?
Calienes: People love your product but they want a price, and the other part of the market is that air-conditioning and mechanical systems are very technical fields. Whoever installed it, before the end user, the developer or the corporate entity, was not as well informed, and they really needed someone locally who has the capability to do the engineering and the design, and they relied on these local companies. Today, customers are much more sophisticated. Large corporations have their own engineering teams. They know what they want and they are more capable of providing value on their own, so the reliance on the local contractors becomes less and less. And when they see a company like Daikin, a $19 billion-dollar, 100-year-old company, they want us to provide a turnkey solution. We are moving in that direction for many reasons, but one is to make sure that our offering is positioned as we want it. We are presenting our value proposition to people who actually need to hear the story.
As the economies shrink, the investment in capacity for electrical generation does, as well. The cost of electricity in Latin America is a huge burden on the industry. We don't see that changing, so we provide energy efficiency and sustainability solutions. Instead of just selling air-conditioning we provide a financial plan. Customers are going to save money by using our equipment. We are trying to change the relationship. We want to sit on the same side of the table as our customer. If we are going to maintain their equipment we make sure that they are seeing the savings, and that message has resonated.
We are also looking at a lot of retro fit applications. There are 300 hotels in Cancun alone, all of them burning fuel every day, 24/7, and I would say that 70% of those hotels need replacement equipment. Through the savings the equipment pays for itself but, because they have not invested in it, no one has the capital to make those decisions.
DHR: You are talking about the changing market. Quality, service, solutions and the cost of ownership used to be first world priorities, not necessarily Latin American. How do you see this in the service industry, and how is that affecting the management team?
Said: The clients will tell you they want more service and to share best practices. In those situations, our experience with management suffering through these types of crisis is helping them [the] first time they have such a crisis. I remember in 2008 all of the people that we knew were crazy about inflation. I gave two or three seminars on how to deal with the crisis because, in 30 years in Argentina in different industries, I experienced devaluation, hyperinflation, going from a dictatorship, all experiences that I would rather not have going on. We need to be very close to our customers. We need to help the customers to deal with inflation for the next couple of years. We need to work very closely with them due to insecurity. That, to us, is very important, looking towards the future and sharing best practices from other countries that have had more of these experiences.
Calienes: In our industry we are in sales as well as consulting, and what we've seen change, and this is what I am hearing, here, is that the situation has changed. Now, we have to be partners. How do we work together as a team, moving forward? Customers are more sophisticated; more educated and want people do their due diligence. Now, the person who is going to buy our product knows the competition, knows the pricing and comes to the table more informed. And we have to be prepared to be able to answer their questions.
DHR: How are you dealing with the talent in this environment in which you have to deliver a true value proposition?
Naintre: In Brazil, the market is shrinking for luxury goods, but it is also buying because the team is trying to find some margins to compensate for the shrinking market. It’s also time to think strategically. We have to think what we're doing. For example, at the same time that the customers all over the world, including Latin America, are becoming more sophisticated, we also need to take into consideration that, in our industry, the Chinese are selling much more reliable products and service than in the past.
In Latin America we have also have seen cheaper prices. People who would like to buy a premium brand at a lower price point. Because we have different Somfy brands, premium brands and two entry-level Chinese brands, we are developing a multi-brand strategy in Latin America for the same customer, selling Somfy brands at a different level of service.
DHR: It’s interesting that customers are able to differentiate and ask themselves if they want a service for a lesser price.
Naintre: Our customers are willing to pay less for a kind of product or a kind of beauty product but, at the same time, the customer wants the same premium brand. We are getting better market share from the Chinese.
DHR: Doesn’t that produce an internal competition between Somfy’s premium and lower brands?
Naintre: It does, and you have to manage that very carefully. We always have somebody from corporate saying "We cannot cannibalize the Somfy brand." But look at the numbers. We are still selling the Somfy brand, but you have to play what is called value/volume. You can make money with volume, as well, because you are providing less service so you have less cost. That's what we are starting to do in Latin America, and they are starting to do it in Asia. They are having to start doing it in North America. And now the team in Europe is starting to think about it. Because they are losing market share to the Chinese. So, the bottom line is that in Latin America you can do all of these things that we are talking about so far and you make money by doing them.
DHR: How are you dealing with the management teams on the ground?
Said: First, you have to access the talent to prepare for the future so that there will be enough room for continued growth. You have to assemble your own team who can work with the larger team as you plan for the future. You need to know which people have room to grow, you need to work with specific programs or training. For some positions, hire people from another company or another division, and not even from the same industry, necessarily. But you need open-minded people inside your organization, or with another point of view that you think will help you grow in the future. The talent is there, but if you don't have the right talent to face the future…
DHR: You are saying that it's not about growth, anymore. The standards in terms of who we want to hire, because we want to redo our strategy, are way higher. There is a rational openness to "Okay, let's hire international talent and screen this." There is an emotional attachment: "Maye we should see local people." How do you see that balance, as opposed to bringing people from abroad where these standards are already in place vs. using just local people?
Said: You have to make that assessment. You must look at people and you must continue training, coaching and development.
DHR: To bring talent from abroad?
Said: Yes, from abroad and different industries. One of my key successes in Argentina was a team built from totally different industries. I want people to be open-minded, to see the business totally differently. I had people from a logistics company, IBM, the military, the chemical industry, Pepsi. It was the best team that I had had in a long time. I am realistic about how to compose a team, how to work with each other, how to create a new team in the field in best interest of the company.
Calienes: It's a real challenge. We are in a very technical field, so there is an apprenticeship, an education period. There are three issues. One is having the right people, but you can't always have the right people at the beginning. When you are small you get who you can get. When we started we hired the best people we could afford. And, of course, as you start to really change into a new phase of your business you manage to make those changes. In fact, 90% of my management team is people who have been there less than three years. People who are in the mindset. And I always say what you cannot train for is ambition. If you don't have that naturally, we can't teach you.
That was an issue that we faced in Mexico. We had a lot of people who were just very comfortable. We had to take out probably 20% of the workforce. Then, you have the right people, then retaining them, which, when you work lean and you spend a lot of time trying to either hire people or find better people, you have to watch the back door. We've seen, in some parts of my organization, a lot of turnover, which we have to address.
DHR: Have you seen a decrease now that we are starting to see unemployment rates go up?
Calienes: The reported unemployment rate in Mexico today is 4.3%. It's crazy. We have hired 29 people, we've lost 20. Sales, engineers, service engineers, administrative people, just a whole host. When you look at the rest of South America there is slightly higher unemployment and some people feel that there is a salary decrease. If you do a double-click, there is actually a different story. What happened in the bubble years was, at the end of the day and with all due respect to people, you were hiring warm bodies to do the job. So, you started to lower your standards. You start to see cost over runs in engineering projects in many areas because there was no one else available. What's happened is a reality check. You squeeze all the people who have doubled their salary, who perhaps didn't have the confidence and capabilities to deliver value for that, they have disappeared. But, with the real capable ones, it has not budged an inch. It's the same look for talent. It's very difficult and it is becoming more and more difficult because the salaries have not changed. If anything, it's become more difficult because the bar is so high. "We need to do it now," went away, now it's: "We need to do it right".
The talent pool, if you look at it as a segment of the population, the actual talent pool of capable people is quite small. It's deceiving to say that you have a huge population of people, because the number of people that are actually capable of doing the job is quite limited. In Mexico, we had all of these manufacturing companies and one of our people went to Kia, and they doubled his salary. They made him an upper manager. He was a sales engineer. But what are you going to do? Good luck!