Samsung's expansion and manufacturing strategy in Brazil

Samsung Electronics

Examination and Evaluation of Business Strategies and Frontier Markets: Brazil

The South Korean company Samsung began operations in Brazil in December 1986 when it opened a representation office. Since them Samsung has invested a total of U.S.$300 million, employs almost 1,000 staff members and has a revenue of above U.S.$500 million. Since May 1994, Samsung has started offering services to Brazilian consumers, and from November 1995 it has produced TV sets and VCRs locally with an initial capital investment of U.S.$18 million.

Starting from July 1997, Samsung has sold its SyncMaster monitors in Brazil had a little later in June 1998; it started to manufacture them in its Manaus factory in Amazon. In 3 years, Samsung measured its control in this segment in Brazil with 40% of the sales (according to IDC Brazil), conquering over companies that were present in Brazil a good deal before Samsung (Sonis, et al., 2007).

The Samsung factory in Manaus is extremely automated. It has been manufacturing the Samsung Voicer cellular devices since March 1999. Following the path of high technology and advanced design, Samsung Slim, Samsung Colors etc. The company produces 1.5 million cellular devices and 1.3 million monitors per year in Brazil (SEC Family News, 2009). Twenty percent of these products are exported to other countries in Latin America. In 2002 Samsung began the production of disk drives in Brazil with total investments of U.S.$35 million and is starting to export them to neighboring Latin American countries (Baer, et al., 1998).

2. Strength and stability of local Currency

The various governments of the 1980s and 1990s were either not willing or capable of devising noninflationary ways to deal with the distributive conflict. That is, not being able to maintain a budgetary equilibrium and thus stability of the money supply, the government undermined credibility in the domestic currency, thus setting the stage for the distributive pressures to manifest themselves through price increases (Baer, et al., 1998).

The Constant Absence of a Fiscal Adjustment

In the period analyzed, Brazil suffered from both inflation and stagnation. This contrasts with most advanced industrial economies, where long periods of stagnations have usually been accompanied by either no price increases or very small rates of inflation. (Note that stagflation was talked about in the United States, but for shorter time periods.) Brazil's stagflation comes as no surprise to the observer, since both inflation and stagnation can be interpreted as being different manifestations of the same disequilibrium (Reis, 1999).

Over the years, Brazil's public sector experienced chronic budget deficits, which were financed by increases in the indexed domestic debt. The problem in the 1980s was the gradual decline of the government's credibility with the public, that is, there was increasing doubt about the government's capacity to service the debt and eventually to repay the principal (Baer et al. 1998). This gradual loss of credibility required the shortening of the terms of financing, reaching a point at which most of the debt was being financed through the overnight market and at increasingly higher real rates of interest. The high interest rates, combined with the large stock of the debt, substantially increased the financial expenditures of the government, whose share in total government expenditures grew rapidly. This created a vicious cycle of rising debt -- leading to rising deficit -- leading to further increases in debt (Fujita et al., 1999).

Brazil found itself in a situation in which an enormous amount of financial resources were invested in the overnight market, which was extremely liquid so that investments could at any time be turned into money, with the possibility of a capital flight into real assets. In 1989, for instance, while the stock of M1 was 1.7% of GDP, M2 was equal to 12% of GDP (Cantwell, 1999). Thus there existed the real threat of a loss of control over the money supply due to the possibility of a rapid withdrawal from the overnight market and/or the exhaustion of financing government deficits through the issue of new debt instruments. The consequence was a growing loss of confidence and the rejection of the national currency, making it easier for the distributive conflict to result in price increases.

Within this context, one finds an explanation to such questions as Why did Brazilian firms grant nominal wage increases with little impact on employment levels? Why did Brazilian consumers accept price increases without significantly diminishing their purchases? In other words, why did the market sanction these price increases, allowing the distributive pressures to manifest themselves through inflation? The answer is that all firms know that they can pass on increases in the prices they pay for inputs to their customers, since the latter prefer to keep buying more expensive products than to hold on to currency, whose value, they believe, will continue to decrease at an accelerating rate (Magalhaes, et al. 2001). Of course, the inflationary process does not resolve the distributive conflict and the generalized indexation scheme "institutionalizes" and worsens the phenomenon.

Within this diagnosis, the inconsistency of the various stabilization strategies attempted during the period under analysis may be worth noting (Miyazawa, 1966). On the one hand, the successive shocks and price/wage freezes were not accompanied by a necessary structural fiscal adjustment. Thus they progressively lost their credibility, and each successive shock had a lesser impact on inflation. On the other hand, the policies aimed at fiscal and monetary austerity were insufficient to attain a reversal of expectations, which was crucial for an effective stabilization program. According to our interpretation of the inflation crisis, confidence in the domestic currency depends on a permanent structural adjustment of public finances (Geddes, 2003). Therefore, simply controlling cash flows, postponing certain expenditures, and devising temporary measures to increase receipts will not achieve the desired confidence as they do not guarantee a future effective control of the money supply. Even more serious, however, is the attempt to control M1 in the short run without a fiscal equilibrium, since this will require very high real interest rates. This situation worsens future problems and will cause growing doubts among the general public about the government's financial stability, as it increases the debt and the cost of its servicing (SEC Family News, 2009).

3. Availability of Raw Materials and Suppliers

Samsung currently being the Number One producer and highest in terms of sales for cell phones, requires cheap and high quality raw materials to compete with the likes of Apple (Number Two) and HTC. The effects of the petroleum crisis forced Brazil to redouble its efforts at export promotion and to change its import strategy. A key to the former was the continuation of Brazil's export incentive program, which, on occasion, came under severe criticism in both the United States and Europe. Another important factor in determining the growth of exports was and still is the rate of growth of the industrial economies that are the importers of Brazil's manufactured goods and industrial raw materials (Miyazawa, 1966).

As a reaction to the world petroleum crisis that drastically worsened its balance of payments, Brazil made various attempts to control its imports and to turn once again toward an intensive import-substitution strategy. Massive investment programs in steel, metal products, capital goods, and petrochemicals and derivatives substantially increased the country's dependence on imports for its industrial growth (Balassa 2004).

Brazil's policymakers were not able to use their crawling-peg scheme with as much liberty as expected. On the one hand, there were pressures to devalue the cruzeiro at a more rapid rate than in the past. The rate of devaluation in the 1970s, especially after 1973, consistently lagged behind the domestic inflation rate (even subtracting the inflation rate of its main trading partners), which was growing again after the steady decline of annual price increases in the period 1967 -- 73. In the 1970s, the export incentive program more than compensated the negative effects of an overvalued cruzeiro. The reluctance to devalue was due to the fear that this measure might add substantial fuel to the resurgence of inflation since the oil crisis. Also, since there was a substantial dependency of Brazilian business on foreign loans, every devaluation substantially increased the cruzeiro cost of the debt (Arnold, 1999). This pushed up internal interest rates and thus discouraged new investments and, hence, the rate of growth of the economy. However, the debt crisis of the 1980s and the pressures by the governments of advanced industrial countries to eliminate or moderate various export incentive programs led the government to decree a number of maxi-devaluations and to adopt a crawling-peg exchange rate that did not lag behind the inflation rate.

The combination the massive inflow of capital after the adoption of the Real in mid-1994 caused a significant appreciation of the new currency. The exchange rate was also used as one of the instruments to stabilize the economy. The net result was a substantial rise of imports and a much smaller growth of exports, causing occasional spurts of protective retrogression. The impact of the Asian/Russian crises, however, led Brazil to abandon its high exchange rate policies and drastically devalue the Real in January 1999.

The Search for Sources of Energy and Raw Materials

Until the late 1970s Brazil was able to provide only 20% of its petroleum needs. (Discoveries of new sources in the early 1980s indicate a decline in this dependency by the mid-1980s to about 50%.) It depended on imported coal for its steel industry, and it had to import such raw materials as copper, tin, zinc, and chemicals. Thus many of its foreign economic policy moves were motivated by a desire either for self-sufficiency in these raw materials or for ensuring secure supplies of these vital inputs. In October 1975, the country made an unprecedented move away from the exclusive reserve of petroleum exploration for the state company Petrobras by allowing "risk contracts," (Baer, et al., 1998) that is, foreign companies were allowed to prospect for petroleum in designated areas of the country, and if the prospecting should bring results, the findings would be split between the foreign company and Petrobras. It was hoped in this way to bring in foreign capital for costly exploration activities and to develop Brazil's capacity to extract petroleum more rapidly.

The drive to increase economic ties with Paraguay and with Bolivia was also motivated by energy considerations (SEC Family News, 2009). The building of the world's largest hydroelectric dam at Itaipu as a joint venture between Paraguay and Brazil has made Paraguay the world's largest exporter of electric energy and contributes substantially to the energy needs of Brazil's center-south. No doubt this will make Paraguay's economy very dependent on Brazil (Cantwell, 1999). Similarly, Brazil's large-scale investments in Bolivia are designed to bring that country's abundant natural gas and other raw materials to the industrial center of Brazil. To assure itself of petroleum supplies, a subsidiary of Petrobras, Braspetro, has made technical assistance and prospecting contracts with Middle Eastern, African, and South American countries. There was also an increase in bilateral trade with former socialist countries for the same reason (Reis, 1999).

4. Geographic Location (e.g for exporting)

Keeping Samsungs R&D and manufacturing plants in mind, as long as Brazil's economy was primarily export oriented, the regional distribution of income was determined by the type of primary exports that were dominant. When the principal source of growth became internalized, however, unequal regional growth and development rates tended to perpetuate themselves or even increase at times (Savasini, 1978).

Hicks, among others, have observed that once unequal rates of growth develop, they tend to perpetuate themselves. The disparity in growth rates may even increase because "as industry and trade become concentrated in a particular center, they themselves give to that center an advantage for further development"(Korzeniewicz, 2010). New firms will tend to settle in the already growing regions, unless there are some special reasons to go to another region, since external economies will make investment in those areas more remunerative. Such external economies consist of more readily available skilled labor and a wide variety of auxiliary goods and services that do not have to be imported. Although the initial reason for the faster growth of such a region might have been some geographic advantage, "it is perfectly possible that they may lose their geographical advantage, and yet they continue to grow, through this advantage of concentration. They grow, that is, by an internal economic momentum"(Miyazawa, 1966).

Although the growth momentum is usually cumulative in the dynamic area, it could, under certain conditions, spread some of its dynamism to other areas. In other words, the growth of the dynamic area can act as a centrifugal force in certain circumstances, but it could also act as a centripetal force and drain the marginal areas of any growth potential they might have had.

Growth can be transmitted from the dynamic to the static region through three basic channels: the movement of goods, of capital, and of labor. Growth transmissions through trade take place when the dynamic region is not self-sufficient, leading to part of the incremental wealth being spent in another, complementary region (O'Grady, 1998). Capital will have incentive to move from the dynamic to the stagnant area only if the vital source of supply to the former needs development. Such movement might create new centers of self-sustaining growth, although it might also simply create an enclave economy in a distant region with little local linkage. With the exception of such an incentive, it is probable that the dynamic center will act centripetally as far as capital is concerned, for with all the available externalities, rates of return on investment will probably be much higher in the growing than in the stagnant region (Cason, 2010).

One would also expect labor mobility to be in the direction of the growing region, for the sake of Samsung Electronics. It is most likely that productivity and earnings of labor are higher in the latter than in the stagnant area. The margin of difference in labor remuneration, or the expectation thereof, will have to be enough to overcome the inertia due to change of patterns of living involved in the movement. On the positive side, labor movement might ease the pressure in the stagnant area and even raise per capita income, especially if there existed a considerable amount of disguised unemployment in the area. Such a movement might also benefit the dynamic center by keeping a steady labor supply on hand, thus preventing labor costs from rising too fast. Labor movement can also be a considerable drain on the stagnant region, since there is usually a greater tendency for younger, more vigorous, and better-trained or trainable individuals to move (Cantwell, 1999).

It can also be argued that if the growing area does not attract labor fast enough from other regions, this might ultimately make the latter seem more attractive to capital than previously. It is more likely, however, that relatively lower wages in the stagnant regions will be offset by lower labor productivity and higher costs in other fields, such as transportation or power (Cason, 2010).

If the dynamics of the situation are such as to result in centripetal forces being dominant, equity considerations might force the government to undertake actions to redress regional inequalities. To what extent can this be done without impairing the growth of the dynamic region? Public policy measures of geographical redistribution can be achieved through fiscal policy and/or direct official measures to encourage firms to settle in the more backward regions (Savasini, 1978).

5. Human Resource issues (e.g. attitudes of the people, wage costs, flexibility of workers)

It should be remembered that one of the aims of the Geisel administration was the improvement of the country's income distribution and the rise in the well-being of the masses, which had not participated in the rapid growth of the "miracle years." It is noteworthy that some of the data available show a rise in real wages (Korzeniewicz, 2010). For example, it is noted that real minimum wages rose almost continuously from 1992 to 2002, although in Rio de Janeiro their growth was neither as steady nor as strong. Average real wages of blue-collar and office workers rose steadily until 1979. Table 1, which shows the proportion of the labor force earning different salary levels, reveals that a large proportion of the labor force earns less than one minimum wage per month. There was a slight decline between 1977 and 1981, but thereafter this proportion rose again (SEC Family News, 2009).

Table 1. Selected Wage and Salary Statistics

Labor Force by Brackets of Monthly Earnings, Selected Years (percent of labor force)

1977

1979

1981

1983

Up to 1/2 MW

13.4

10.9

12.1

12.7

More than 1/2 to 1 MW

20.9

18.5

15.8

18.3

More than 1 to 2 MW

24.7

25.2

24.7

22.8

More than 2 to 3 MW

10.2

10.7

12.6

11.8

More than 3 to 5 MW

8.6

9.8

10.2

8.9

More than 5 to 10 MW

5.8

7.0

7.0

7.5

More than 10 to 20 MW

2.6

3.0

2.9

3.3

More than 20 MW

1.3

1.3

1.3

1.3

With no earnings*

12.5

13.6

13.4

13.4

Total

Notes: For 1977 and 1979 the rural population of the Northern Region and the states of Mato Grosso do Sul, Mato Grosso, Goias are not included.

For 1981 and 1982 the rural population of the Northern Region is not included.

*Includes those who received only social security benefits. People with no earnings are not included.

MW = minimum wage.

It should be stressed that the wage policies designed to obtain greater equity in the distribution of income were introduced at the end of the 1970s, when Brazil's inflation/balance-of-payments crisis worsened. This has led to a considerable debate over the impact of the wage policy: whether it was effectively redistributing income and whether it was one of the main causes of the acceleration of inflation (O'Grady, 1998).

The best analysis of the impact of Brazil's wage policy was made by Roberto Macedo. He pointed out that pressures for new wage policies originated in 1974, when the annual inflation rate doubled from about 20% to about 40% (a plateau on which inflation remained until 1979). Thus the pressure for semiannual wage readjustments was based on the consideration that if "nominal wages are readjusted on an annual basis, when the rate of inflation doubles, the fall in real wages between readjustments will lead, within this period of time, to a lower yearly average real wage. Simple intuition suggests that…this larger decline in real wages were reduced in the same proportion by which the rate of inflation was increased" (Arnold, 1999).

Macedo also showed that the accelerated inflation of the late 1970s began before the new wage policies were applied, that is, the inflation was clearly accelerating in mid-1979, whereas the new wage policies began only in November 1979. 33 Once the policies were carried out, they contributed to the inflationary pressure to the extent that the government's price control authorities recognized them as legitimate cost increases to be passed on to higher prices (Balassa 2004). Thus, as wage cost increases were viewed as justification for increased prices, the government was implicitly following a policy of not redistributing income through wage policies. Another interesting aspect of the wage policy, from an equity point-of-view, is that it was more onerous on small firms than on large firms. It has been shown that large firms employ a smaller proportion of unskilled labor than smaller firms. Thus the differential wage increase policies have been a greater burden on the latter than on the former (Korzeniewicz, 2010).

6. Environmental issues (Climate, environmental regulations etc.)

It was obvious that domestic and foreign firms such as Samsung would want to invest in Brazil, close to their major markets. In addition, since this advanced region contained more skilled workers and professionals and had the country's best infrastructure facilities, inherited from the coffee boom, considerations of lower costs from external economies also persuaded most firms to settle there (O'Grady, 1998).

Even within the southeastern region, industries were concentrated in a small number of locations (greater Sao Paulo, the Baixada Santista, Campinas, Rio de Janeiro, and Belo Horizonte). This concentration resulted in enormous pressures on government to provide adequate infrastructure for the growing number of industrial firms, that is, adequate transport facilities, power supply, and so forth. However, each sector had its own emission of effluents into the ground, water and air -- automobile firms, textile mills, chemical firms, and the like -- and their nearness to each other resulted in rapidly expanding pollution. In addition, the growing reliance on road transportation for people and goods further contributed to increasing air pollution (Cason, 2010).

Until recently, the pollution resulting from regional industrial concentration was not countered by policymakers. The basic reason was that prior to the 1980s there was hardly any awareness of environmental degradation as a major policy issue. Also, the government was so preoccupied with the stimulation of new industrial investments, that any explicit concern with the issue would have seemed as being detrimental to such efforts (Balassa 2004).

With ISI there was rapid urbanization. Whereas in 1940 31% of Brazil's population was urban, by 1950 this proportion had increased to 36%, by 1965 to 50%, and by 1989 to 74%. The population, which in 1990 lived in cities of 1 million or more, was about 48% of the total urban population. This change was due to rapid rural-urban migration. The dramatically rapid rise of people living in cities was not accompanied by an adequate increase in the urban social infrastructure and explains the rapid growth of urban slums, where people lived without adequate water and sewage systems, health and educational services, etc. (O'Grady, 1998).

Recent studies show evidence of some decline in urban-industrial polarization. The recent more outward-directed development, congestion in the greater Sao Paulo region, technical and organizational changes, state policies providing special incentives and subsidies to attract industries, and the influence of MERCOSUL, among others, resulted in a reduction in industrial concentration. However, changes were not really expressive. In fact, what we observe is industrial expansion along a few industrial corridors (eixos) emanating from a nucleus that is clearly (Sao Paulo et al., 2008). They include a few industrial development corridors leading to the interior of the state of Sao Paulo; a corridor from Sao Paulo to Belo Horizonte; and one from Sao Paulo to Porto Alegre in the extreme south, passing through Curitiba and the industrial cities of Santa Catarina state. All these corridors stem from the industrial metropolis of Sao Paulo; moreover the decline in physical industrial concentration is far from reducing the control exerted by the central nucleus of the system (SEC Family News, 2009).

In 4 decades of industrial growth Brazil's industrial structure underwent considerable changes (see Table 2). There was a notable relative decline of industries like textiles (from 20.1% in 1949 to 5.25% in 1990), food products (from 19.7% to 11.85%), and a rapid expansion of industries like transport equipment (from 2.3% to 7.7%), electrical equipment (1.7% to 8.64%), and the group of chemical-pharmaceuticals-perfumes-plastic products (9.4% to 19.89%).

Table 2 - Changes in Brazil's Industrial Structure: Percentage Distribution of Gross Value Added

1949

1963

1975

1980

1985

N. Metallic Minerals

7.4

5.2

6.2

5.8

4.30

Metal Products

9.4

12.0

12.6

11.5

12.21

Machinery

2.2

3.2

10.3

10.1

9.20

Electrical Equipment

1.7

6.1

5.8

6.3

7.56

Transport Equipment

2.3

10.5

6.3

7.6

6.43

Wood Products

6.1

4.0

2.9

2.7

1.58

Furniture

2.0

1.8

1.45

Paper Products

2.1

2.9

2.5

3.0

2.94

Rubber Products

2.0

1.9

1.7

1.3

1.84

Leather Products

1.3

0.7

0.5

0.6

0.60

Chemicals

12.0

14.7

17.33

Pharmaceuticals

9.4

15.5

2.5

1.6

1.69

Perfumes, Soap, Candles

1.2

0.9

0.89

Plastic Products

2.2

2.4

2.24

Textiles

20.1

11.6

6.1

6.4

5.95

Clothing & Shoes

4.3

3.6

3.8

4.8

5.17

Food Products

19.7

14.1

11.3

10.0

12.01

Beverages

4.3

3.2

1.8

1.2

1.24

Tobacco

1.6

1.6

1.0

0.7

0.76

Printing & Publishing

4.2

2.5

3.6

2.6

1.94

Miscellaneous

1.9

1.4

3.7

4.0

2.67

TOTAL

Source: IBGE, Industrial Censuses and Anuario Estatistico, various years.

The most rapidly growing industrial sectors were also the ones with the highest degree of pollution potential, especially in firms in the chemical-petrochemical, metal products, and transportation materials sectors (see Table 2). It should also be noted that since until the 1980s the growth of industries occurred behind highly protective barriers and the emphasis by various governments was on attracting as many industries as possible by minimizing regulations that would be perceived as adverse to the profits of these industries, environmental regulations were not too strong (Sao Paulo et al., 2008). This resulted in the incorporation of technologies that were not the most advanced and that were not environmentally friendly. Samsung Electronics would be well advised to keep this in mind, with the global affinity towards greener companies. When combined with the extreme spatial concentration of industries, the emerging industrial structure was most conducive to growing pollution. Since until recently there was no systematic collection of pollution data, one must rely on some case studies to illustrate the environmental impact of industrialization.