The Auto-Parts Industry in Brazil under the INOVAR-AUTO

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1 The Auto-Parts Industry in Brazil under the INOVAR-AUTO -Huge New Opportunities for Japanese Companies- Paulo Hirai Ugo Ibusuki Instituto AOTS Alumni São Paulo January 16 th, HIDA Research Institute

2 Abstract In the last two decades, Brazil has undergone a deindustrialization process due, to a large extent, to the country s macroeconomic decision to overvalue the Real (Brazil s currency), as part of the policy to end the hyperinflation plague. The auto-parts industry revenue went from US$12.2 billion in 1990 to $11.3 billion in 2002 and to $41.8 billion in However, the imports evolved from US$0.8 billion in 1990 to $4.1 billion in 2002, reaching $16.3 billion in While overall revenues grew a little over three times, imports grew almost 20 times in the period. Competition from imports caused many local manufacturers to become unprofitable. After years of overvaluation, the Real is finally getting back to its purchasing power parity, evolving from R$1.70 per dollar in 2012 to the current R$2.30 per dollar. The Brazilian Government launched the INOVAR-AUTO (Innovate Auto), a program to encourage the use of more auto-parts made in Brazil (Mercosul), to increase automobile efficiency, and to foster innovation, among other objectives. The country s current negative balance of payments is influencing the Government to provide support to the local industry. This incentive program was set by the Brazilian Ministry of Development, Industry and Trade. In order to qualify for the significant tax incentives (up to 30% of the vehicle sales price) provided by INOVAR-AUTO, automakers have to increase the use of auto-parts made locally (Mercosul) while at the same time improve automobile efficiency. This new environment creates a challenge for Brazilian auto-parts manufacturers as most of them do not have the technology or financial strength required to meet the newly created demand. This represents a great opportunity for Japanese auto-parts manufacturers that have the required technology to enter the Brazilian market. Keywords: Brazil, Automotive, Auto-parts, INOVAR-AUTO, Incentive, Opportunity 2014 HIDA Research Institute 1

3 The Auto-Parts Industry in Brazil under the INOVAR-AUTO Huge New Opportunities for Japanese Companies Introduction The Brazilian Automobile Industry is booming. Domestic sales reached 3.63 million vehicles in 2011 and 3.80 million in 2012, according to the Brazilian Automotive Yearbook (ANFAVEA, 2012) putting Brazil in the fourth position globally behind China, USA and Japan, and ahead of Germany, France and Korea. The industry expects sales to reach 4.5 million vehicles in 2015 and over 6 million in 2025, with huge investments already announced by automobile manufacturers of more than US$30 billion until In 2012, the automobile industry represented 18.7% of the Brazilian Industrial Gross Domestic Product (Industrial GDP) and 4.2 % of the Brazilian GDP. Brazil has made great progress as a vehicle manufacturing country, but the local industrial base of automobile and auto-parts companies has been experiencing a two-sided phenomenon. On the one hand, the growth of the demand for automobiles is making the entire auto-parts industry grow. On the other hand, imported auto-parts are expanding rapidly as the overvalued currency favors imports to flood the country. Many local auto-parts manufacturers have been suffering from strong import competition and have been slow to react to the growing demand. In the last five years, the deficit of the auto-parts industry trade balance has increased strongly (figure 1) and cars manufactured in Brazil have increased the use of imported content (table 1). Figure 1: Brazil s Auto-Parts Industry Trade Balance (US$ billion) , Figures in Billion USD Exports Imports Balance Source: Sindipecas (2013) 2014 HIDA Research Institute 2

4 Table 1: Impact of Auto-Parts Imports (US$ billion) Auto Parts Total Sales Auto Parts Sales to Assemblers Imports % Imports/Auto Parts Sales 11.8% 43.3% 39.7% 40.9% 47.5% 33,0% 37.4% 40.9% 56.1% Source: Sindipecas (2013) Automobile imports also soared and reached 850 thousand vehicles in 2011, accounting for almost 25% of total domestic sales. Automobile trade balance is also negative as shown in Figure 2. Figure 2: Brazil s Automobile Industry Trade Balance Source: ANFAVEA (2012) The competitiveness of the supply chain installed in Brazil has been weakening. The New Automotive Industrial Policy (INOVAR-AUTO) was designed to help change this unfavorable situation. 1. The Brazilian Automobile Industry The Brazilian Automobile Industry is comprised of 18 manufacturers (of which 13 are passenger car manufacturers) and 37 plants (of which 15 are in the area of Sao Paulo), with a total production of 3.4 million units (2011) and domestic sales around 3.6 million units (2011 including imports), as shown in table 2. The automobile industry is responsible for about 150,000 direct employees. In 2011, Volkswagen, Fiat, General Motors and Ford had about three quarters of the domestic market-share: these are all first comers, the remaining being mainly new comers. The domestic market has been the main focus but the export market is gaining importance. Export market opportunities are increasing due to demand from 2014 HIDA Research Institute 3

5 emerging markets and Mercosul, a Free Trade Agreement (FTA) within Argentina, Brazil, Paraguay, Uruguay and recently joined by Venezuela. Table 2: Production and Sales Volume of Brazilian Auto-Manufacturers Passenger * Commercial Total production Share Export Share Domestic (incl. import) Share Market Position Volkswagen 828,444 83, , % 187, % 765, % 1 Fiat 762, , % 87, % 754, % 2 GM 643, , % 97, % 632, % 3 Ford 286,357 40, , % 67, % 344, % 4 Renault 220, , % 60, % 194, % 5 Peugeot Citroen 146, , % 24, % 175, % 6 Hyundai 38, , % 0 0.0% 114, % 7 Toyota 60, , % 12, % 99, % 8 Honda 85, , % 13, % 92, % 9 Daimler 9,347 63,706 73, % 0 0.0% 73, % 10 Nissan 32, , % 0 0.0% 67, % 11 Mitsubishi 39, , % % 55, % 12 Iveco 0 20,585 20, % 0 0.0% 20, % 13 Volvo 0 27,866 27, % 3, % 20, % 14 Scania 0 22,496 22, % 5, % 14, % 15 Agrale 0 6,725 6, % % 5, % 16 International 0 2,189 2, % % % 17 Others % 0 0.0% 199,721 TOTAL 3,153, ,095 3,420, % 561, % 3,631, % *passenger car including light commercial vehicle - bold: first comers, italic: new comers Source: ANFAVEA, 2012 a) First Comers: Product development strategies adopted by the first comer car assemblers located in Brazil (VW, Fiat, GM and Ford) have been less centralized than the later strategies of the new comers. These companies have been manufacturing and assembling cars in Brazil since the 1950 s (except Fiat, active since the 1970 s), and have kept a relatively stable and strong position in the Brazilian car market. During the phase of industrialization via import substitution and a protected internal market (until 1990 s), these assemblers built local decentralized product engineering areas for designing and developing products specifically focused on the local market, often adapting old European and North American models. Domestic sales 2014 HIDA Research Institute 4

6 volumes were sufficient to maintain these activities in Brazil, although at a level of technological sophistication considerably lower than that of European counterparts. However, with trade liberalization and greater integration into global strategies commanded by parent companies, such subsidiaries have substantially changed their products and R&D strategies in Brazil. They have redefined the way their products are conceptualized, designed and engineered, seeking cost reduction through elimination of asset and task duplication, particularly in their technological facilities and engineering staff. b) New comers: These assemblers moved into Brazil only recently, following trade liberalization in the 1990 s. There are distinct product strategies adopted by these new comers. PSA Peugeot-Citroen and Renault/Nissan have realized that investment in local development is essential to create products adapted to local needs in order to expand market share. Toyota, Honda, Hyundai and Daimler in the passenger car segment, and Mitsubishi in the light commercial vehicle have launched products in the Brazilian market which have not only been conceptualized and designed for developed markets, but whose re-engineering (adaptation to local technical and taste conditions) has been carried out abroad, either in Europe, the US, Japan or Korea. Toyota has just launched a new global small vehicle (Etios) produced in the new plant of Sorocaba, but its development is completely centralized at the headquarters and while the team of engineers of its Brazilian subsidiary, responsible for the product development, does only minor adaptations locally. Honda is also expanding its line-up in the smaller car segment, with the launch of the Fit and City; there is also ongoing investment in local R&D focused on local design and local adaptation (flexible engine/ethanol engine and off-road design) as well as product validation. 2. The Brazilian Auto-Parts Industry In recent years, several new organizational arrangements have been implemented in the Brazilian Automobile Industry. Among these are the modular consortium and industrial condominiums, both of which are factory organizations entailing close car assembler and supplier collaboration, in terms of the share of investment, location areas, services provisions and also, in the former case, of the workforce. These have led to a series of transformations as well as the internationalization of the supplier base operating in Brazil, with a large number of mergers, acquisitions, alliances and closures. The new arrangements are characterized by a high degree of outsourcing, long-term contracts, co-design, specific asset and information exchanges, and general mutual dependency. Table 3 indicates the origin of capital (Brazilian or foreign) before and after these changes HIDA Research Institute 5

7 National capital Table 3: Composition of Total Sales and Investment 1994, 2002, Foreign National Foreign National Foreign Total Total capital capital capital capital capital Total Sales 52.4% 47.6% 100.0% 24.4% 75.6% 100.0% 28.2% 71.8% 100.0% Investments 52.0% 48.0% 100.0% 14.1% 85.9% 100.0% 33.7% 66.3% 100.0% Source: Brazilian Auto-parts Industry Performance - SINDIPECAS 2013 Total Brazil s auto-parts industry underwent a major denationalization. In 1994, companies with national capital had a little over half the market (sales) and in 2012, it was reduced to 28.2%. Table 4 shows the countries of origin of the foreign auto-parts companies in Brazil. It is noteworthy that the Japanese auto-parts participation is shy compared to the near 11% market share of the Japanese assemblers. Table 4: Companies Distribution According to the Foreign Participation 2002, 2012 Countries 2002 Countries 2012 United States 31.1% Germany 25.2% Germany 24.8% United States 23.0% France 6.3% France 8.6% Italy 5.9% Italy 8.1% Spain 5.2% Spain 8.1% Japan 4.6% Japan 5.4% United Kingdom 2.8% United Kingdom 3.2% Other countries 19.3% Other countries 18.4% Total 100.0% Total 100.0% Source: Brazilian Auto-parts Industry Performance - SINDIPECAS 2013 The above-mentioned arrangements usually imply the delegation of responsibilities to suppliers, who assume design and manufacturing functions, which in turn increases their power within the supply chain. The literature points to a shift from the traditional competitive and short-term client-supplier relationship to strategic partnerships of long-term collaboration. In other words, companies are encouraged to abandon the traditional buyer-seller relationship in favor of a more stable and collaborative relationship with their suppliers. Auto-parts commerce in Brazil has shown consistent growth in recent decades, with total sales increasing more than three times in the period from 1990 to 2012 (table 1). This might be explained by the constant investments in this sector, especially in the mid-1990s. Moreover, the implementation of the Plano Real in 1994 was also important as it indexed the local currency Real to the US dollar and controlled the high inflation rates, which plagued the country; as a result, this encouraged automotive commerce. With its adoption, the Brazilian 2014 HIDA Research Institute 6

8 currency got stronger and the economy grew allowing many consumers to afford new cars, especially with the increased availability of cheaper imported ones. Because of this, and as the effects of the economic plan were consolidated, the importation of auto-parts grew. In many years, these imports exceeded export growth, generating a trade deficit in auto-parts. Over the period, the Brazilian auto-parts trade balance was negative (-5.8 billion dollars in 2012) although in 2006 it was positive (1.9 billion dollars). A strong currency together with low local productivity is leading to auto-parts industry deindustrialization. 3. INOVAR-AUTO Program The Brazilian New Automotive Industrial Policy (INOVAR-AUTO) has several objectives. The key ones are: increase the use of auto-parts made in Brazil (Mercosul), increase automobile efficiency, and foster innovation. Launched in August 2011 by the Brazilian Ministry of Development, Industry and Trade, it has a long-term perspective (2013 to 2017). INOVAR-AUTO was structured based on an additional 30% over vehicle sales price, as hiked IPI (Industrialized Product Tax). The idea is to reduce this additional tax based on the achievement of certain goals set by the Government. One of the central points is that the reduction of the additional tax will depend on the amount of regional purchase of auto-parts (including die/mold) made locally (Mercosul). The IPI reduction is based on the amount of regional purchase adjusted by a factor of 1.3 in 2013, decreasing in the following years down to 1.0 in 2017, making clear that for the future the tax will go up unless the automakers increase the use of locally made auto-parts. There are other requirements with established targets like minimum investment in R&D and Engineering (Basic Industrial Technology), minimum local manufacturing steps (stamping, welding, painting, plastic injection, engine assembly, transmission assembly, steering and suspension component assembly, electrical system assembly, brake system and axle assembly, body assembly, final assembly, laboratory), vehicle labeling related to fuel consumption homologated by INMETRO (National Institute of Metrology) and target of 12% fuel consumption reduction until 2017 based on 2012 measurement HIDA Research Institute 7

9 Condition for IPI Reduction Table 5: Qualification Requirements for INOVAR-AUTO (passenger car) Minimum Number of National Manufacturing Processes (mandatory) Gross revenue invested in R&D (optional) Gross revenue invested in Engineering (optional) Car labeling - % of models (optional) IPI Reduction Based on the Amount of Regional Purchase Adjusted by Following Factor % 0.50% 36% % 0.75% 49% % 1.00% 64% % 1.00% 81% % 1.00% 100% 1.00 Source: Federal Government (2012) INOVAR-AUTO will require a formidable adjustment in the auto-parts industry. Basically, the industry needs to: Invest quickly Improve management Improve quality Improve productivity Improve customer service Develop skilled labor Re-position in the auto value chain All these adjustments will take a long time to implement. It will also require investments that are beyond the capacity of the existing Brazilian companies in the auto-parts sector. One alternative is to bring new companies from abroad. Another possibility is to make Brazilian established companies grow through joint ventures with foreign auto-parts companies. The Brazilian auto-parts market is in a special situation that favors Japanese auto-parts companies willing to come to Brazil as the demand for auto-parts is high, the imports are also high but the Government wants to reduce it as part of the efforts to reduce the country s balance of payments deficit. The alignment of so many favorable factors for a foreign company is rare in the world and should at least be analyzed and considered. Japanese companies of Tier 2 and 3 are already being requested by Japanese assemblers and Tier 1 companies to become a local supplier to them as they expand in Brazil. Their quality is clearly superior to that of auto-parts made locally, the productivity is also better and the service level is unparalleled. These competitive advantages can be used to succeed in Brazil s market. Moreover, the Japanese car manufacturers are working hard to expand their current 11% market share to much more, possibly doubling this share in the coming years. There are many ways to enter the Brazilian auto-parts market. Joint ventures may be the fastest and less risky way to enter the market HIDA Research Institute 8

10 4. Issues to Consider When Entering Brazil s Market For most Japanese companies, running an operation in Brazil may be very challenging as the business environment is quite different from the ones in Japan or in the USA. Labor laws, tax laws, business ethics, and many other issues generate additional risks for the new comers when running an operation in Brazil. Even joint ventures with local companies, without adequate local knowledge, may evolve to a distrustful situation between the parties. In the past, many Japanese companies ignored the peculiarities of Brazil s market and business environment and failed. For example, HIDA-AOTS Sao Paulo recently analyzed a case of a Japanese entrepreneur that established a deal with Brazilian partners to manufacture incinerators for waste treatment in small towns, without analyzing the environmental laws. After producing a dozen of incinerators, they finally realized that the company could not sell a single unit. The Brazilian partner knew nothing about the environment protection acts in Brazil. The Japanese entrepreneur implied that by complying with the environmental laws in Japan it would automatically be OK in Brazil. A costly mistake. As an example of a successful partnership, a small Japanese company with a special technology for preventing pipes from being clogged by fat and other materials by using electrostatic process, teamed up with a very knowledgeable local entrepreneur with the right characteristic for the venture (knowledgeable, serious, with excellent network, sensitive to the Japanese way of thinking) and is doing very well. Today, only the key electronic components are imported from Japan. Plastic case, wiring and switches are all locally made, reducing costs. The ability of mutual understanding led to these key actions to reduce import taxes without interfering with the product quality. Today, Japanese companies can count on services provided by HIDA Research Institute ( with dependable and knowledgeable local people for help with market studies, partner search and support during the early days of running the operation in Brazil. For joint ventures, a peculiar Governance setting needs to be implemented to assure a long lasting healthy relationship. HIDA has a vast network in various business areas making it unique to carry the preparatory activities to enter the market and provide support in the initial operation, with people who understand both sides (Japanese and Brazilian), speak Japanese and are very dependable. Synthesis of the Analysis and Conclusion Brazil s automotive industry is important for the economy. However, the current situation is such that Brazil is not taking advantage of the industry with too much imported cars and auto-parts, contributing to deteriorate the country s balance of payments. The New Automotive Industry Policy (INOVAR-AUTO) was designed to change the current situation using tax incentives (tax punishment ) to make imports less appealing and to foster the development of local manufactured automobiles and auto-parts, improving the entire supply chain (ex. die/mold) HIDA Research Institute 9

11 Increased productivity, quality improvement, and innovation are all included in the INOVAR-AUTO. The key question is how to drive medium and small size companies to develop technology, improve management, add innovation, and do all these in a few years. The answer means a great opportunity for Japanese Tier 2 and 3 companies that possess good technology, good management processes and some capital to invest. Many of these companies already supply to Toyota, Honda, Nissan and Mitsubishi in Japan, in the USA, and in some Asian countries, and could supply them in Brazil as well. Current market share of the Japanese car assemblers in Brazil is only around 11% (for the first 10 months of 2013), suggesting that partnering with a local company could help this local company to comply with the INOVAR-AUTO rules and to serve not only the Japanese assemblers but also the first comers (VW, Fiat, GM and Ford). Many local companies are willing to explore new partnerships but they know nothing about what is available in Japan that they could take advantage of. Business services provided by HIDA Research Institute is a good way to know more about the opportunities in Brazil. Taking advantage of the opportunity in the right moment in the fourth largest automobile market is almost imperative HIDA Research Institute 10

12 References ANFAVEA, Annual Report of the Brazilian Automobile Industry, Sao Paulo, 2002, 2011, Ibusuki U., Kobayashi H., Yingsham J., Asian Automobile Manufacturers Strategies in Brazil: Impact of the New Automotive Policy (INOVAR-AUTO), GERPISA Colloquium 2013, Paris. Sindipecas, Brazilian Autoparts Industry Performance, Federal Government (2012) Plano Brasil Maior: New Requirement, Brasilia HIDA Research Institute 11

13 About the Authors Paulo Hirai President of the Instituto AOTS Sao Paulo (HIDA Brazil) with a large business network in Brazil. Actively directs the Instituto s activities to support Japanese companies interested in entering Brazil s market and develops ways for a successful entry and operation in Brazil. Received a degree in Mechanical Engineering, and in Business Administration. Trained at MIT (Sloan School of Management) and in Japan. Work experience in Brazil, Argentina, USA and Japan. Extensive experience in doing business in Brazil as Senior Executive and Board Member of large and medium size companies. Ugo Ibusuki Doctor in International Studies at the Graduate School of Asia-Pacific Studies of the Waseda University and a Visiting Researcher at the Research Institute of Auto Parts Industries of the same university. His main research field is INOVAR-AUTO and the impact in the Brazilian and Japanese Automobile Industry. Currently, he is also Lecturer of the Postgraduate Program in Project and Technology Management at the University Center of FEI, and a Senior Manager of Bus/Truck manufacturer working for more than 15 years with product development in Brazil as well in Japan HIDA Research Institute 12

14 An introduction to the AAS Instituto AOTS Sao Paulo is a recognized institution for quality management, and a bridge for many Brazilian companies interested in doing business with Japanese companies and for Japanese companies interested in knowing about particular markets, starting an operation, finding a good partner for a joint venture, or technology arrangement in Brazil. It has over 50 years of experience developing critical human resources, training Brazilian engineers and executives in the Japanese Management System and developing an ample network within the business community and Government. It is a distinctive organization with over 2,000 associates in various industrial areas, making it capable of developing in-depth studies for market entry in many economic segments. It provides invaluable support to Japanese companies interested in the Brazilian market, minimizing local risks and maximizing the likelihood of success HIDA Research Institute 13