Brazil’s economic growth ground to a virtual standstill last year, and as the first quarter of 2013 comes to an end, there are no clear signs of a recovery. Rather, inflation is tilting upwards and retail sales are slowing. The latter is a big deal as it implies a dip in consumer confidence, which flies in the face of the normally calm response of Brazilians to periods of macroeconomic volatility. Brazil is a nation of spenders more than savers, after all – a trait that saw luxury goods expenditure more than double between 2005 and 2012 (at fixed US dollar prices).
There are contradictory signals in the retail sector, however. For one thing, 2013 is set to see a record number of shopping malls open across the country – more than 40 in total. The lacklustre economic environment does not appear to be slowing their development. On paper, these malls ought to provide an attractive platform for luxury goods growth. The JK Iguatemi mall in Sao Paulo, which opened in June last year, has given the likes of Burberry, Gucci, Prada, Lacoste, Coach, Dolce & Gabbana, Tod’s and Mui-Miu strong new footprints in Brazil, for example. Indeed, JK Iguatemi has raised the bar on shopping mall developments in Brazil, and is widely regarded as a new template for luxury retail real estate.
Yet, if retail spending continues to weaken, there is a danger that this upcoming wave of shopping malls will lead to surplus capacity, reducing footfall in individual malls. One argument is that Brazil’s high net worth individuals are not exposed to the economic slowdown in a way that will make them change their shopping habits. There are upwards of 20,000 (US dollar) millionaires in São Paulo. Click to Tweet! And the rationale is that they will continue to shop at JK Iguatemi and other luxury enclaves (such as the myriad boutiques on Lorena and Haddock Lobo in the Jardins district). It will not necessarily play out that way, however.
The problem is that retail sluggishness is often contagious, and if malls start to become half empty, it follows that the lure and entertainment factor of visiting a shopping mall will be hugely undermined. As a result, Brazil’s wealthiest consumers could start to drift away, and do more of their shopping in cities such as Buenos Aires and Miami, or even London and New York.
Similarly, middle-class Brazilians – those who dabble on the fringes of the luxury goods market – could start to do more of their shopping in Ciudad del Este, a Paraguayan free-trade city on the Brazilian border. Brazilians already account for around 90% of retail spend in Ciudad del Este, and with good reason. Click to Tweet! In its malls and street markets, they can buy all manner of luxury brands, from Italian shoes to super premium Scotch whisky. Crucially, they can buy Western brands at lower prices than they are likely to find anywhere else in the world, and for much less than in Brazil.
Positioning is a critical problem for the luxury goods industry in Brazil. Ultra-high import tariffs mean that luxury brands are typically positioned much higher than in Western markets. This is a characteristic of imported consumer goods in general. It is not uncommon to pay four times as much for a pair of Levis jeans in São Paulo than in New York, for example. As a result, high import taxes have blurred the definition of luxury. Most strikingly, fast fashion chains are forced to move upmarket when they open in Brazil, meaning the likes of Topshop (which opened in JK Iguatemi last year) are positioned more as an affordable luxury brand than as cheap chic.
When it comes to luxury imports, brands are often positioned so high as to alienate all but the wealthiest groups. Indeed, one of the luxury goods industry’s biggest missed opportunities over the past decade has been its failure to tap effectively into Brazil’s rapidly expanding middle class. Although luxury goods have shown upbeat growth in Brazil over the past seven years, actual domestic expenditure is quite low in the global picture. Click to Tweet! It is less than in Australia and Canada, for example. Yet Brazil is the 10th biggest retail market in the world, and it ranks
well ahead of both those markets in almost all fast-moving consumer goods categories. Quite clearly, the domestic luxury goods market is already losing substantial business to Paraguay, Argentina and Western markets. The scales could tilt even more unfavourably over the year ahead.
The big picture
Luxury goods manufacturers and retailers with an eye on building new positions in Brazil should not be too daunted, however. Yes, Brazil’s luxury goods market is over dependent on high net worth individuals, and yes, the economy has lost some of its shine over the past year. But, Brazil is unlikely to be in the economic doldrums for too long. The economic fundamentals are strong. And there are still opportunities for luxury goods growth based purely on Brazil’s demographics. The population of social classes A and B is forecast to grow by over 2.5 million to 2020, for example. That is on a par with projections for the whole of Western Europe.
Brazilians also have a natural penchant for luxury and pampering. Import tariffs need to come down, but if that happens, there could be a surge in demand for affordable uxury goods. The emerging middle class is waiting in the wings, and will fuel demand for all manner of products, from handbags to electronic gadgets. Tablets and smart phones are already starting to see strong new demand in the northeast, which is home to around 30% of Brazilians.
It is also important to keep in mind that Brazil will host both the Fifa World Cup in 2014, and the Olympics in 2016. These global events will have a positive knock-on effect in the retail sector, and could give shopping malls new leases of life. Rio de Janeiro, which will stage the next Olympics, looks particularly attractive for luxury retail investment.
Brazil is definitely going through a leaner time at present, certainly in comparison to the past decade, but manufacturers and retailers of luxury goods have every reason to be confident of medium- and long-term growth. There is strong pent up demand for luxury goods in some second-tier cities, where many of the new shopping malls will open. And a short period of market correction might even yield positive outcomes. For one thing, it could result in attractive deals for retail real estate leases.