Latin America Industry Scenarios:
Convergence or Fragmentation in Retail?

Bernardo S. Sichel
Director, Latin America DSI

“Latin America industry scenarios” is a new column highlighting some of the key uncertainties, plausible outcomes and business implications of future industry scenarios in the region.  Later articles will cover other industries served by Decision Strategies International, including pharmaceuticals, telecommunications and financial industries.

Latin America represents a market of more than $1 trillion dollars in consumer buying power. About three-quarters of this buying power is concentrated in the top three markets (Mexico, Brazil and Argentina). Additionally, urbanization is relatively high (over 74% in the top three countries) and mostly concentrated in cities of over 1 million inhabitants.[1]

In this attractive environment, global retailers have been successful, especially in those markets where they entered ahead of other global competitors. This has been the case with Wal-Mart in Mexico ($10.7 billion in sales, 4.5% net margin and leader with a 40% plus market share in 2003) as well as Carrefour in Argentina ($1.3 billion in sales and market leader with 30% plus market share) and Brazil ($3.3 billion in sales and second in market share).

Despite some “customization” of their models (e.g., neighborhood markets), global retailers have achieved their success by replicating the proven approaches of their core markets. The rationale has been that as economic growth continues, and disposable income rises, lower income consumers will trade up to global brands and buy in more modern retail outlets.

Prospects for future growth depend upon whether assumptions about continued rapid consumer convergence prove accurate. How quickly will the tastes of consumers in emerging markets converge with those of the developed world? Apart from economic growth, there are other forces such as economic integration, income distribution, consumer attitudes towards globalization and global brands, the rise of populism and traditional retailer’s resilience that could play a role in the behavior of emerging market consumers.

The implications for global retailers are enormous. With around half of total food sales currently being sold through modern outlets in Latin America (the percentage is even less in other markets)[2], global retailers are betting they can access a good part of the other half of the market to fuel their growth. This has prompted companies such as Wal-Mart to increase their presence in Brazil, despite the current dominance of market leaders Companhia Brasileira de Distribucão (CBD) and Carrefour.

Latin America retail scenarios

Scenario thinking is a great tool to imagine the possible future scenarios of retail in Latin America. To build preliminary retail scenarios for Latin America we considered two major uncertainties: the convergence of consumer behavior and the changing regulatory environment, resulting in four distinct and relevant business scenarios (see Figure 1)

Figure 1

The Consumer Behavior axis captures the attitude of emerging consumers towards global brands and modern outlets in the next 10 years. Convergence indicates that there are similar preferences toward global brands and purchasing behaviors among economic segments in the region, as well as between emerging consumers and those of more developed countries. Fragmentation means the opposite will happen.

The regulatory environment dimension describes the level of intervention in the retail industry in the next 10 years. A “restrictive” environment indicates that there are regulations governing the ownership, opening, size and/or operation of retail outlets by global players. An “open” environment would be relatively free of such restrictions. As shown in the matrix, these two uncertainties form a framework for four possible scenarios for Latin American retailing.

Scenario A: Mom & Pop’s Rule

In the “Mom & Pop’s Rule” scenario, purchasing habits across the different economic strata and between emerging consumers and those in the developed world do not continue to converge. Furthermore, restrictive regulatory measures are set in place to limit the expansion of the global retailers and their modern outlets. The retail industry remains fragmented.

In this scenario, the addressable market for global retailers (and large local retailers) is severely limited, intensifying the competitive environment and fostering important changes in the type of formats and business models to serve the consumer base. Although a private label strategy would favor local preferences, there might not be enough scale to develop a proper franchise, even through alliances with local manufacturers.

If adequately monitored by the global retailers, this scenario could lead to a preemptive abandonment of some countries, or even the region, to invest in more attractive opportunities elsewhere.

The key drivers of this scenario are the lack of economic growth, no further economic integration, especially with the US, a rise in populism across the region, and further discontent with globalization and global brands at the consumer level.

Scenario B: Incumbent’s Paradise

In the “Incumbent’s Paradise” scenario, purchasing habits across the different economic strata and between emerging consumers and those in the developed world continue to converge. However, there are restrictive regulatory measures in place that limit the expansion of the global retailers and protect the small and medium-sized neighborhood outlets.

In this scenario, the addressable market for large retailers is expanding beyond the growth of the region. However, retailers who are not already in the markets or region will be left out and those who are in may have to play by new rules of the game (size, location and/or hours of operations). Even so, it is an ideal scenario for incumbents since there is less of a threat of new players coming into the market and capturing a slice of the profit pie. Given the expansion of the market and the convergence of tastes and behavior, private-label franchises can be expanded as part of a global or regional strategy.

This scenario favors gaining an early position in the markets and solidifying domestic alliances to improve the lobbying position with national and local governments. This seems to be Cencosud’s approach in the Argentine market. While already a player with its Jumbo hypermarkets, it is expanding its position by acquiring Coto supermarkets from the troubled Dutch retailer Ahold.

The key drivers of this scenario are several years of sustained economic growth (to increase disposable income and improve access to global products), some level of economic integration (to lower the cost of imported goods) and the embrace of global brands by consumers. This scenario also needs either a period of temporary crisis (e.g. like the Argentine crisis that catalyzed Law 12,573[3]) or some kind of nationalistic stance against the developed world by the government to promote restrictive measures.

Scenario C: Cashier Wars

In the “Cashier Wars” scenario, there are no regulatory measures that limit the expansion of global retailers but purchasing habits across the different economic strata and between emerging consumers and those in the developed world do not continue to converge.

In this scenario the addressable market does not expand at the anticipated rate since there is no economic growth to fuel it. Although there are no restrictions to entry, additional global retailers refrain from entering the market due to the lack of growth opportunities. Internal rivalry in the market is high as large retail players (early entrants and local) compete for the attention of a limited number of middle-class consumers. In this environment, private label strategies need to be customized to local tastes and preferences, but there are limitations due to the size of the market.

This scenario is a very difficult one for global retailers, since the lure of emerging market opportunities and the lack of restrictions can drive heavy investments in anticipation to market growth. The key for global retailers already in the market is to achieve profitability (through consolidation and other measures) until the markets rebound, economic growth returns and convergence becomes again a possibility.

The key drivers of this scenario are economic stagnation (disposable income does not rise to the required levels for low income consumers to gain access to global brands), no further economic integration, especially with the US, and further discontent with globalization and global brands at the consumer level. Another driver is the shift of interest of global retailers away from the region and into other parts of the world.

Scenario D: Wal-World

In the “Wal-World” scenario, purchasing habits across the different economic strata and between emerging consumers and those in the developed world continue to converge. There are no restrictions for global retailers to operate and expand in the region.

This scenario is the base case assumption made by many global retailers operating in the region. The addressable market is expanding much faster than the economies, and global retailers can gain access by continuing to offer their proven successful developed-world models. New formats are developed not so much to serve different types of consumers as to serve similar consumers in their different purchasing environments  (e.g., neighborhood markets and convenience stores). Finally, given the expansion of the market and the convergence of tastes and behavior, private label franchises can be expanded as part of a global or regional strategy.

This scenario allows global retailers some flexibility to time their entrance to the market and to do so without the need of local partners, as was the early approach used by Wal-Mart in Argentina and Brazil. However, the retail industry in the region is getting more concentrated every year and it will be extremely difficult for late comers to achieve critical mass without a significant investment or acquisition (as Wal-Mart is doing in Brazil with the acquisition of Bompreço from Ahold).

The key drivers of this scenario are several years of economic growth, economic integration, a pro business stance of government towards business and an embrace of emerging consumers towards globalization and global brands. Another driver could be the early investment of global retailers to create a virtuous cycle of convergence (access to global brands stimulates convergence, which in turn promotes more expansion and lower consumer prices, which in turn stimulates even more convergence).

Takeaway

Latin America, like other emerging markets, will provide ample growth opportunities for global retailers. If the history of the region has taught us anything, it is that regulations, economics and consumer behavior are far from predictable. The assumptions about rapid convergence and open regulatory markets may not play out as originally planned. In this uncertain environment, those players who take a broad view of the market, plan for multiple futures and try alternative models will be the ones who will reap the benefits, no matter what future unfolds.

If you would like to further explore this subject, please refer to the whitepaper “Retailing Opportunities in Latin America: Insights for Global Retailers” (www.thinkdsi.com) or contact us at: sichel@thinkdsi.com or (610) 717-1000.