Copyright Mario Tama, Getty Images
Protests in Rio de Janeiro, Brazil, Aug. 16, 2015, called for the ouster of President Dilma Rousseff following revelations of corruption involving the government and the oil company Rousseff chaired for seven years before being elected president.

Bruisings in Brazil

Sept. 1, 2015
“What the government wants to and has to do long term is simplify taxes state-to-state. We cover Rio and Sao Paulo, and you might be incented to have warehouse in nearby state and ship across state boundaries. It’s certainly manageable, but it could be a lot simpler.” - Bob Eisenbrown, EDGE Global Supply

A confluence of civil unrest, an economy faltering on falling commodity prices and a corruption scandal involving the country’s largest oil company and high-level government officials have turned Brazil, one of the world’s superstar growth markets just a few years ago, into a challenging place to do business.

The country’s troubled economy keeps getting hit with bad news. Consumer confidence is at a record low, unemployment is climbing and recent market turmoil in China, Brazil’s largest trading partner, has caused further concern. Inflation is high as Brazil’s currency, the real, slumps, and the latest report on gross domestic product was expected to show that the country is officially in a recession.

“It’s been an interesting year for the Brazilian economy. A lot has changed even from a year ago,” says Bob Eisenbrown, president of Edge Global Supply, Milwaukee, Wis. Edge Global Supply is a joint-venture company set up by 11 industrial automation-oriented electrical distributors to pursue opportunities overseas, and Brazil was the focal point for its first two rounds of acquisitions, announced in early 2014.

Edge Global Supply’s Brazil operations saw strong business conditions through last year, with a fall back in the first part of this year that was partly expected for cultural reasons. The first half of the calendar year in Brazil is full of festivals such as Carnaval and numerous religious, state and federal holidays, so the second half is when most of the business happens. Given the challenges mentioned above, Eisenbrown said, the second half should be better.

“There’s a tendency to spend on a calendar year budget cycle, so we expect business to increase, but it’s not the environment we had the last couple of years before that,” Eisenbrown said. “We’re not like some of the big players who’ve decided to exit market. We’re long-term bullish. It’s just too big an economy to ignore.”

Global electrical distribution giant Sonepar SA, Paris, likewise saw enough promise in the Brazilian market to buy rival Rexel’s operations in Brazil, Chile and Peru in April this year. The deal, completed at a time when many of today’s troubles had already become apparent, added 1,400 associates and 88 locations with annual sales of €250 million (approximately US$280.1 million) to Sonepar’s existing Brazilian operations, which it began building in 2001.

“Our group’s expansion policy has the abiding support of our family shareholders, and that is what made it possible for us to achieve this deal, because there won’t be a quick return on investment. A key advantage of our ownership structure is that we can pursue a strategy grounded in a long-term vision that also includes profitability as a requirement, given that we finance our business out of our own resources,” said Franck Bruel, Sonepar’s CEO, at the time of the acquisitions.

The scandal at state-run oil giant Petróleo Brasileiro SA, known as Petrobras, has forced a cutback in investment in the country’s dominant oil-and-gas sector. What began in March 2014 with an investigation into money laundering called Operation Car Wash expanded to cover allegations of corruption at Petrobras, where it is alleged that executives accepted bribes in return for awarding contracts to construction firms at inflated prices. Prominent Brazilian politicians and businessmen are under investigation in regards to “suspicious” contracts worth $22 billion.

Shock waves through the rest of the economy since the investigation began, compounded by declining crude oil prices and foreign exchange rates, have nervous businesses and consumers cutting back on spending, and layoffs have further weakened demand. In 2015 through July, Brazil has lost nearly a half-million jobs, according to the Labor Ministry, The Wall Street Journal reports.

“Even with all the stuff going on, they’re predicting 1%-2% GDP growth, so it’s not like the chasm we saw in U.S. in ’09, but we certainly would like to see it become more robust,” Eisenberg said. “Some of the things that have happened, such as rising energy prices and new safety legislation, have placed the focus on upgrades and retrofits, while brownfield and greenfield construction we’re not seeing as much.”

The majority of the business Edge companies do with Petrobras is focused on operations and maintenance, while the corruption scandal is focused on construction engineering contracts for large expansion projects. The faltering price of crude oil may have as much to do with the slowdown as the Petrobras scandal.

“We’ve definitely seen in the oil & gas market a general hesitancy. It’s hard to tell if that’s related to corruption or just to the price of oil. As we’ve seen around the world, people are still producing — they have to keep the plant running — so they can’t not spend the operations money, but capital improvements are down, like in the oil industry generally. We’ve seen more cautious behavior as far as spending, but they’ve got to keep production moving, that’s their lifeblood,” Eisenberg said.

“We would love to see more robust environment, because it’s still a big opportunity. Global and national companies down there are investing in new products, new models of cars, new production in the tire industry,” Eisenbrown said. “Brazil is a pretty diverse economy.”

Other industries including iron, sulfur, sugar, soy, paper, metals production are also major producers, he said. “It’s pretty diverse. Only Mexico in the whole Latin American region would be similar in terms of a broad portfolio not tied to commodities and resources.”

Doing business in Brazil has been a learning experience for Edge Global Supply. The country is technically very advanced, says Eisenbrown, but some internal nuances of doing business are more cumbersome than in more developed western countries. For example, use of electronic commerce is far less prominent in Brazil, in part due to convoluted tax regimes.

“In our business, and in general, online transactions are extremely minimal because of the complex value-added tax structure. Amazon’s presence is very minimal. eBay too,” he said. “If there’s one thing Brazil is good at it is collection of tax and automating collections. This makes it difficult to do e-commerce.”

Edge Global Supply has helped its Brazilian companies improve their online presence in a way customers there can use. “We’re just making sure the web has the information our customers want, but the actual transactions are done the conventional way. There’s some EDI, but not much. That tax code complexity inhibits the rate of how fast it will go.”

In terms of general customer relationships, just doing business, Brazil is not at all a third-world country, Eisenbrown said. “It’s a mature economy, with mature business practices. They’re different, but it’s not like they haven’t been thought out. The things customers value are pretty similar to what we see in the U.S. market.

“We do more value-added packaging because when you do value-add, you can avoid some of the taxes on the original purchase,” he adds. “What the government wants to and has to do long term is simplify taxes state-to-state. We cover Rio and Sao Paulo, and you might be incented to have warehouse in nearby state and ship across state boundaries. It’s certainly manageable, but it could be a lot simpler.”

Edge’s U.S. partner companies are all Rockwell Automation distributors heavily involved in the industrial market, and the partnership with Rockwell has helped them understand the Brazilian market. Rockwell has had a separate company in Brazil for many years, not just selling its automation equipment but designing and building PLCs in Brazil.

“They have a very high level of education down there. There’s no lack of technical skillset,” Eisenbrown said. “They certainly have the ability to absorb and apply automation. It’s a good market for automation, with a large portfolio of international manufacturing companies established there. Because of tax and import duties, to be competitive, they have to have some production in that market, and that history has transferred that knowledge to be effective in Brazil.”