Automotive market in Brazil under significant pressure

1. Roland Berger study: Car sales for 2014 expected to decrease by up to 12% and commercial vehicles by as much as 25% vs. 2013
2. Production for passenger cars impacted even more (-20% vs. 2013) due to lack of demand from the Argentinean market
3. No immediate recovery in sight. With the currently weak economic situation, market expected to remain below 2013 volumes at least for the next 2-3 years
4. Overcapacity and high cost structures lead to significant profitability problems – Few market participants without losses
5. Immediate actions required by OEMs and suppliers to reduce fixed costs, reduce exchange rate impact and even review their future Brazilian product and production strategy

São Paulo (Itaim Bibi), September 11, 2014

The automotive market in Brazil is suffering heavily from the weak macroeconomic environment and lack of consumer confidence. The demand for passenger cars in 2014 is expected to contract by approx. 8-12% and reach 3.2 – 3.3 million units compared to 3.6 million units in 2013. January through August, actual sales were 10% below the same period in the previous year. Production is additionally impacted by the economic crisis in Argentina with local demand down by 26% January through August 2014. The commercial vehicle sector is equally depressed and expected to shrink by up to 25% in terms of sales and production by the end of 2014.

According to the recent study, "Market perspectives Brazil 2014-2018 – Current market challenges and counter strategies," the situation is not expected to improve any time soon. "Brazil is in the middle of an economic adjustment heavily impacting the automotive industry. These adjustments traditionally last 2-3 years in Brazil," says Stephan Keese, Partner at Roland Berger Strategy Consultants in São Paulo and head of the Automotive & Industrial Goods Practice in South America.

This year, the economy is expected to grow by a meager 0.5% according to the Brazilian Central Bank. Some independent analysts foresee even lower growth rates. Furthermore, with forecasted annual growth of 2-3%, the outlook for 2015 to 2018 remains well below the growth dynamics for which Brazil was known in the past 10 years. "The Brazilian automotive industry depends heavily on the overall economy, consumer confidence and access of the burgeoning middle class to financing – and all three are not in a good shape," adds Keese.

Considering that the industry had recently prepared itself for well above 4 million units of production per year, most manufacturers and suppliers are struggling with significant overcapacity. OEMs in Brazil are reported to have dismissed 9,000 people since the beginning of the year, approx. 10% of their entire workforce.

The situation among suppliers is equally problematic. "Only a few suppliers that already restructured early on during the current downturn or that have a unique product positioning are capable of generating any profit in Brazil at the moment," says Martin Bodewig, responsible for Roland Berger's automotive supplier cluster in South America. "Brazil is the most important problem in the regional portfolio of a global automotive supplier." The Roland Berger experts estimate that a 20% decline in the market will impact the profitability of an average automotive supplier by approx. 5 percentage points. This decline reduces the estimated low average profitability of 2.5% for the automotive supply industry in Brazil even further. The global average for 2013 is estimated at 6.5%.

Profitability improvement through holistic restructuring

With the restrictive labor laws and the high fixed cost structure in Brazil, many companies are currently struggling to adjust their cost base to the lower revenue base. "Only a holistic restructuring approach aiming at a new strategic and operational setup in Brazil and Argentina can help at the moment," says Bodewig.

Suppliers need to work on all levers of operational excellence. The cost of imported material has increased significantly due to the exchange rate development of -20% over the last 12 months and need to be reduced via localization. Automation and productivity are becoming significantly more important to mitigate the 7-8% annual labor cost increases. Logistics costs and inventory need to be managed according to world-class standards to leverage their improvement potential.

In addition, suppliers also need to work to "right-size Brazil" and lower their break-even point. Many companies still work with a footprint heavily dependent on the very expensive São Paulo region, while other regions can offer cost reduction potential of up to 5%. Overhead and administrative structures are typically less efficient than in other regions and offer reduction potential of as much as 20%. The product portfolio needs to be aligned with future OEM requirements and reviewed under long-term profitability aspects.

Summary: Quick action needed

With the slow recovery of the market in the years to come, OEMs and suppliers alike need to prepare for a scenario of reduced profitability. Given the rapidly increasing cost structure, this scenario will worsen the profitability situation of market participants even more. The experts from Roland Berger advise suppliers to act quickly to launch actions necessary to minimize losses and prepare the local setup for the future.

• Photos iZonda/iStock