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IMPORT SUBSTITUTION The Brazilian Experience
Import substitution is one of the priorities of the Russian economy and implies developing of the domestic industry while reducing the dependence on foreign partners along with the creation of a stable supply chain and long-term competitive advantage. To find a solution to this problem it is useful to learn from the experiences of other countries, such as Brazil, where with the help of localization policy a local supplier base was successfully created.
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Localization encourages public and private companies to be more engaged in the country’s economy, to develop industrial production, train their personnel, and also build local networks of equipment and services suppliers. Successful import substitution creates added value to the national economy in a form of a supply chain and has a multiplication effect on adjacent industries. Governments of many gas and oil producing countries such as Brazil, Kazakhstan and Uganda have been making more stringent demands for import substitution in order to maximise benefits from the extraction of their resources. Within the framework of import substitution, NOCs play a particularly important role as they become the main source of capital, expertise, technology and the best management and operational practices for local firms due to increasing quotas of the latters in their supplies. Strategy& has been working over several years with national governments of different countries and major oil and gas companies to develop the most well-minded and efficient methods of import substitution. Our project in Brazil may be of particular interest.
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Oil Discovered In 2007, Brazil announced the discovery of large ultradeepwater oil reserves at a depth of 7 km. Brazil is no longer dependent on the oil imports today as developing these fields has made the country one of the world leaders in the oil market. At the same time the Brazilian government faced the task of using the development of the oil fields for the benefit of the whole society, i.e. for diversification of the economy, stimulating competitive industrial growth, new job creation and improving the country’s non-rental income levels. In 2003, the Oil & Gas Brazilian Industry Mobilization Program (PROMINP) was created, and it has become a platform for discussion of development initiatives for the extractive related industries by representatives of all stakeholders: the Brazilian government, extractive industry companies, trade unions, financial institutions, suppliers of equipment and services, and educational institutions. PROMINP studies have shown that there were gaps present in the supply chain which could potentially be localised. Strategy& was assigned with the task of developing an import-substitution strategy for these segments. It was important to answer the following questions: 1. Which materials and equipment could be manufactured locally and what services rendered could be localised in Brazil? 2. Which methods of import substitution could be used? How the companies could be supported in building the required competencies? 3. What investments were required and what effect would import substitution have on the country’s economy? 4. How could we ensure that enterprises supported by the government would later reach self-sufficiency?
strategy Brazil
Strategy& started its project with an analysis of similar programs in other countries that were either successful (Norway, United Kingdom, Korea) or unsuccessful (Indonesia and Venezuela). The lack of success with import substitution programs in Indonesia and Venezuela can be explained by several factors: constantly changing regulations that scared off potential investors and entrepreneurs, the lack of a clearly defined import substitution plan as well as incentives for foreign companies to share their know-how and technology.
Successful Experience One of the most frequently cited success stories is the creation of a high-tech oil and gas industry in Norway after the discovery of oil fields in the North Sea in the late 1960s. At that moment Norway had no operating company for oil and gas and that is why the government owned oil company Statoil was founded.
A favourable economic situation allowed the government to adopt a long-term strategy of resources extraction under which production was increased gradually (income from production did not exceed 25% of the GDP), and Statoil and its local suppliers could progressively develop the appropriate competencies. Labour costs in Norway were higher than in most countries so the authorities focused on creating high-tech jobs with high added value. Norwegian authorities set up a cluster in Stavanger where they established an oil and gas university and a research centre and built the appropriate infrastructure: an airport, office buildings, warehouses, etc. Stavanger authorities focused primarily on involving major operators forming demand for services and equipment, such as Exxon and Phillips, and then created the appropriate conditions for successful operations of their partner companies.
The state supported cooperation between companies, research centres and universities, encouraging investment in R&D and the knowledge dissemination in the oil and gas sector. There are 2,500 companies operating in Stavanger today and 50,000 jobs have been created. The oil and gas industry employs about 50% of the workforce in the region. Norwegian companies such as National Oilwell Varco, Seadrill, Subsea 7, Aker Solutions, PCS are now global service providers in the oil and gas industry. Other examples of production clusters are Aberdeen in the UK, also created at the end of the 1960s for oil production in the North Sea, Onne Oil and Gas Free Zone in Nigeria and Rotterdam in the Netherlands. These clusters were able to attract hundreds
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of companies and create thousands of jobs through the development of transport and telecommunications infrastructures, organisation of business parks with reduced rental rates, scientific research centres, and also financial assistance in the form of reduced taxed and the allocation of grants. Lowering the level of bureaucratisation (e.g., abandoning licensing of the import and export of equipment and accessories) and active promotion of the cluster to the business also contributed to the solution of the task. The analysis of the experience in Norway and several other countries shows how large industrial clusters can be successfully created and become centres of innovation and entrepreneurship, where national oil and gas companies become economic drivers. Nonetheless, this strategy of clusters creation has to be well-weighed; a careful analysis has to be done to identify which sectors will have the greatest synergy with gas and oil production: e.g., exploration services and engineering, shipbuilding, production of equipment or petrochemicals. Having analysed the experiences of other countries, Strategy& had to realistically assess the performance capabilities of Brazil. Perspectives looked optimistic: the country expected great economic growth and an influx of investment in new fields, while the stable political situation singled Brazil out advantageously against many other gas and oil producing countries. The global oilfield services market related to exploration and production showed strong growth (an average of 11.5% per year) and the aggregate demand for them was estimated at $400 billion up through 2020 what created favourable conditions for import substitution. At the same time the industry was very concentrated: in most sectors, more than 90% of
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One of the most frequently cited success stories is the creation of a high-techoil and gas industry in Norway after the discovery of oilfields in the North Sea in the late 1960s
the market belonged altogether to four global companies. In some sectors large demand resulted in bottlenecks and large backlogs what along with significant offshore production potential in deep and ultra-deep waters created good opportunities for Brazilian companies in the international market. However there were just 199 companies operating in the exploration and production segment at the moment in Brazil and most of them did not export. Analysis showed that the Brazilian economy’s structure had a number of problems that prevented local companies from competing with foreign suppliers.
National Features A survey was conducted among the suppliers of oil and gas companies, of which 64% said that for them competition was a significant problem. Among the main competitors they listed companies from the USA, China, the UK, Germany, Norway and India, and their main competitive advantages cited were low prices, better technologies, higher quality and lead time. Analysis of the vendor list showed that 40% of the commodity groups had no local suppliers, in other 40% majority was comprised of the foreign companies and in just 7% of the commodity groups only national companies were present. Among the reasons for their low competitiveness Brazilian suppliers named high taxes, lack of qualified workforce, high cost of capital and other factors (see Figure 1).
Our research confirmed that Brazil was considerably less competitive by these parameters in comparison to a number of foreign countries. Strategy& also interviewed direct customers in order to find out the main impediments to the sector competitiveness . They named the following factors: supply uncertainties, risk excessive pricing, margin addition on non-value added steps, culture of pricing for "negotiation“, and lack of scale. The survey of multinationals doing business in Brazil helped to understand their perception of the Brazilian industry in comparison with other countries (see Figure 2) and identified the influence of the same systemic factors: the excessive tax burden, high cost of capital, lack of qualified labour, etc. Strategy& also carried out a more profound comparative analysis of the business of one of those international companies that had been operating in Brazil for 25 years and had offices in Europe and Asia. The study showed that the Brazilian unit was realising products only in the local market with low engineering need. The Brazilian factory was 14 times smaller than the Asian one and moderately automated because of smaller volumes of investment. Our analysis demonstrated that Brazil’s costs of production were higher than in Asia and some higher than in Europe. Labour cost in Brazil was 2.43 times higher than in Asia, the cost
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Figure 1. Main obstacles to Brazilian companies (% of suppliers)
High taxes Lack of qualified workforce High cost of capital Bureaucracy Lack of access to technology and equipment Lack of access to loans and insurance Cost of raw materials
Figure 2. Brazilian industry in comparison with other countries (% companies)
Tax Logistics Cost of capital Cost of equipment Scale Cost of raw materials Labour productivity Manpower costs Worse
of raw materials 1.4 times, the cost of components 1.35 times. In total, the price for Brazilian equipment was 55% higher and this equipment often lacked quality. All in all it appeared that the national oilfield services sector was diversified and had good potential for growth but it was very fragmented, focused on the domestic market, lacked technology and scale of operations in spite of spare capacities. Moreover, the companies’ expenses were significantly higher than those of foreign competitors. Thus, localisation policy had to include measures aimed to increase the scale of operations and consolidate, support exports and investments in know-how and new technologies.
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Strategy& worked out detailed recommendations on import substitution for a number of the industry segments. It was necessary to ensure the compliance of the desired scale of import substitution with possibilities of the country, and the availability of production and labour resources. We made a “cost-benefit” analysis on a number of measures supporting import substitution. So we evaluated what efforts were needed to change one or another negative factor and which benefits would derive as a result. One of the problems was the lack of technical staff. We estimated that the cost of training and retraining personnel was approximately equal to the positive effect of new jobs creation.
At the same time the impact of creating a technological industry significantly surpassed R&D investments while investment into radical increasing of the scale of production was not likely to pay off fully. After that, we evaluated the strengths and weaknesses of local suppliers in order to identify areas in which they had the greatest potential. Based on this analysis we developed a targeting matrix where all segments of the industry were divided into three categories: • segments for which the gains of development of the segment would exceed the efforts requires (e.g., shipyards); • segments for which the gains and efforts would be approximately equal (e.g., tubes and pipes); • segments for which the gains would be smaller than the efforts required (e.g., seismic); The segments of the first and partially of the second category were selected as significant for import substitution. Also we analysed the experience of the Brazilian companies that were successful in the international market. They faced the following difficulties: • dependence on one major clients, Petrobras, was minimized due to working in different sectors, exporting the most part of products and building long-term and strong relationships with Petrobras; • the lack of technical personnel was overcome by the activities of a permanent training centre, a partnership with the network of SENAI vocational schools and measures aimed to retain valuable employees; • basic projects were developed abroad so companies actively cooperated internationally, carrying out direct dialogue with engineering firms to adapt their equipment to local requirements;
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• high cost of raw materials were compensated by vertical integration, large-scale orders, purchase of raw materials directly from the producer while purchasing all imported components and raw materials via tenders; • high cost of capital was surmounted by uptake in the market and from financial agents; • the modest scale of operations was compensated by arrangement of conveyor lines into two or three shifts and a partial outsourcing; • the internal fiscal optimisation service worked on minimising the tax burden.
Recommendations Strategy& consolidated the best practices and developed a series of recommendations to improve the competitiveness of Brazilian companies. Firstly, it was important to give local manufacturers access to contracts and technologies, to support the creation of joint ventures, allowing the learning of experience and competencies. As part of improving labour productivity it was essential to create and disseminate knowledge, provide funds for R&D. Business had to cooperate more with educational centres for manpower training as well as to revive engineering companies with the help of financial support and, if necessary, the involvement of foreign engineers. It was also necessary to provide Brazilian companies with access to advanced technologies and modern equipment.
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In the process of bid selection by means of specialised mechanisms, it was necessary to encourage local companies producing goods for export or those that could compete in the global marked. A system of incentives was required for firms giving advantage to local suppliers, for example, by giving them preference in the bidding on the development of new fields and or compensating costs associated with the lack of experience of local companies by offering discounts on licenses. National companies also had to strive to include local suppliers in their foreign projects and consider the possibility of buying shares in supplier firms with the idea of further reselling when the company would increase its volume and become competitive. Industrial production had to be increased in 4-5 technological clusters and scientific and technical centres should have been created to attract the best experts. Selected industries were to be given financial relief in these clusters. The state was to simplify and improve the transparency of import substitution policy, to provide funding and encourage venture capital investment in the oil and gas industry as well as to ensure tax burden equality for local and foreign companies, e.g. with the help of a special fund for tax refunds. It was
recommended to negotiate with companies, government officials and raw material suppliers to determine methods of reducing raw materials prices up to global levels (e.g., by increasing the volume of purchases, reducing taxes, creating more efficient transport infrastructures and simplifying environmental legislation).
Result Today Brazil is one of the world’s leaders in the development of deepwater fields. The country has managed to create a local supply chain in the oil and gas industry and optimise the use of local infrastructure. Domestic companies have been compelled to improve their efficiency, working on par with foreign companies. The cooperation between Brazilian business and oil and gas corporations has increased, the share of local suppliers in the oil and gas industry exceeded 70% mainly due to the national company Petrobras that has actively promoted the development of engineering and oilfield service companies in Brazil. The positive effect of import substitution is being carried over to related industries: the heavy industry, electronics and automotive. Brazilian clusters actively attract service and extraction companies to investment into R&D. In November 2014 the $500 million Global Technology Center at the Federal University Technopark of Rio de Janeiro was opened that will bring together 400 researchers specialising on developing advanced subsea oil and gas technology.
Ekaterina Kozinchenko, General Director, Partner Strategy& Russia Arthur Ramos, Partner Strategy& Brazil Dmitry Mordovenko, Senior Executive Advisor Strategy& Russia
Photos from the sites: WIKIPEDIA.ORG, PETROBRAS.COM, FREEIMAGES.COM, VIRTUALPHOTO.NET, HEALTHXL.ORG
» Today Brazil is one of the world leaders in the development of deep water fields. The country has managed to create a local supply chain in the oil and gas industry and optimise the use of local infrastructure
