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Brazilian Auto Market Presents Challenges, Opportunities for Suppliers

Executive Summary

Foreign parts makers first set up shop in South America’s leading economy when it was an emerging market, but Brazil has grown in status and “is not a low-cost country anymore,” a top Bosch executive says.

TRAVERSE CITY, MI – Brazil may be a difficult place to do business, but the country is the world’s fourth largest automotive market, with sales of an estimated 3.5 million vehicles this year, growing to 5.2 million by 2015, says J.D. Power do Brasil’s Jon Sederstrom.

Vehicle production is expected to grow to 4.4 million units in that timeframe, he says.

The bad news is taxes and labor costs are high. It takes an average 2,600 hours a year for a company to comply with government paperwork.

Most of all, the competition is fierce, particularly among suppliers, says Besaliel Botelho, executive vice president-Robert Bosch Latin America, noting there are 504 members of the Sindipecas suppliers organization, most of them international companies.

“This market is booming, no doubt,” Botelho says at the Center for Automotive Research’s Management Briefing Seminars here. “But we have some important challenges to deal with.”

One of them is volume. Production in Brazil is based on a large number of platforms, with one of them underpinning 200,000 units, he says. This keeps suppliers thriving. ZF Brazil saw $1.1 billion in sales last year, Botelho says, while Bosch Brazil reached $2.5 billion.

Brazil is the economic engine that drives South America. Its largest trading partner, Argentina, sold 679,000 vehicles in 2010 and is forecast to grow to 783,000 units by 2015, says J.D. Power. But Argentine-made vehicles contain only 30% local content, compared with Brazil’s 80%, Botelho says.

Foreign parts makers first set up shop in Brazil when it was an emerging market, but with inflation, labor contracts and a strengthening currency, “Brazil is not a low-cost country anymore,” he says.

Several years ago, production started falling below sales, making Brazil a net importer of vehicles. “We are not capable of exporting anymore,” says Thomas Schmidt, vice president-operations at ZF Brazil. “Those who are still exporting do it because of contractual reasons.”

Import duties are severe: 100% for vehicles and 30% for parts. Sales taxes are high, as well. A car costing $30,000 in most markets is priced at $48,000 in Brazil. The least-expensive car available is the Chery QQ, at $15,000, despite transportation and import duties.

Botelho says auto maker and supplier organizations are lobbying the government to reduce labor costs and sales taxes to return the advantage to local manufacturing.

As in the U.S. and some other countries, there is a shortage of engineers that Botelho says could reach 30,000 by 2015. Because Brazil has specific needs, including extensive dependence on ethanol fuel and vehicles that can handle deplorable roads, global platforms need to be adapted to local conditions.

Additionally, consumers are price-sensitive, with 1.0L cars making up half the market.

For suppliers, Brazil’s auto industry presents several opportunities, some involving technology. Airbags and antilock braking systems, for example, will be mandatory in 2014. Today, only 6%-8% of vehicles come equipped with them. Additionally, diesel-engine trucks will have to meet Euro 5 emission rules in 2012.

Another lure for suppliers is that General Motors, Fiat, Ford, Mercedes-Benz, Volkswagen and PSA Peugeot Citroen all have tech centers in Brazil.

“Customization is essential,” says ZF’s Schmidt. Gasoline contains a minimum of E25 ethanol (75% gasoline), which affects combustion. Diesel fuel is 500-1,800 parts per million of sulfur.

Uniquely in the world, Brazil’s light vehicles run on sugarcane-based ethanol, a renewable resource. More than 90% of cars in the market are flex-fuel capable.

“You have gasoline at E25, and you have E100 (hybridized with 7% water) and you have diesel,” says Botelho. “You can drive from south Brazil 4,000 or 5,000 miles (6,437 to 8,047 km) to the north on ethanol. We’ve been using ethanol as a fuel for 35 years.”

Thus, suppliers with new ethanol technology might have an advantage in Brazil, he says.

More auto makers either are arriving in Brazil or expanding their operations. Honda is adding capacity, Toyota is building a plant and Chinese companies Chery, BYD and Jianghuai Automobile are starting with imports and planning to construct assembly facilities.

Among the suppliers that have entered Brazil recently are those connected to Japanese OEMs, but the arrival of any new players is an opportunity for suppliers, says Kurt Wilks, director-sales and engineering at Mann & Hummel.

Linking a supplier’s fortunes to a single customer is risky, says Chris Powers of Oliver Wyman, but being close to an auto maker is a distinct advantage, making geography important.

For instance, Fiat is planning a plant in far northeast Brazil, where there is little automotive infrastructure. The nearest rival is Ford’s Bahia factory that includes a supplier park for 26 companies.

Botelho says OEMs have announced investments through 2014 of $21 billion, and suppliers have committed $5 billion. Some 70% of auto makers’ investments are by established players such as Volkswagen, Fiat and GM, while 30% come from new entrants like Toyota, Hyundai and the Chinese.

“The Chinese are coming, but they are more or less exploring the market first,” says ZF’s Schmidt. “In the end, they will have the same taxes as the other OEMs. Will prices be lower because of competition? I don’t think so.”

Despite the barriers, Brazil’s growing market presents opportunities for new arrivals. “The key will be to have a good local consultant to guide them,” he says.

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