From Hyperinflation to Healthy Growth: Brazil's emerging economy and the semiconductor industry

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While today's global economic volatility leaves many emerging economies worried about the degree to which they are exposed and thereby may suffer new setbacks, some are forging ahead relatively unscathed. The International Monetary Fund (IMF) has forecasted Brazil's growth to be around 4.8% for Y2008, quite significant given both the debilitating debt default of 1987 and today's global economic climate. In support of this forecast, during 2Q07 Brazil's growth "on a[…] twelve month basis […] reached 5 percent," according to Anoop Singh, Director of the Western Hemisphere Department, IMF (www.imf.org/external/np/tr/2007/tr071020a.htm). 

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Brazil has come a long way in a short time; some might even say that the old joke, "Brazil is 'the country of the future.' And it always will be," may finally be put to rest. Early May saw Standard & Poor's and then late May saw Fitch Ratings award investment-grade status to Brazil; both are truly historical events. The two rankings confirm and underscore Brazil's economic solidity and pave the way for new investments
(http://seekingalpha.com/article/79498-brazil-s-ready-for-big-fixed-income-investors?source=d_email).
With reserves in the US$200 billions, Brazil has finally proven its rightful grouping by Goldman Sachs along side of Russia, India and China as the "'BRIC' countries that collectively represent the world's economic future"
(www.economist.com/displayStory.cfm?story_id=11052873).

With sizable government backing, greater efforts to stop smuggling of chips, initial improvements in IP protections, "a set of tax and other incentives to attract multinational chip makers"
(http://www.eetimes.com/showArticle.jhtml?articleID=201803504), and the realization that a hungry consumer market has awakened, the time is right to look to Brazil and strategize. In fact, the first movers are already there.

The Brazilian IC dream
The recent Brazilian economic growth brings with it a stable political environment, increased credit and lending, contained inflation, an emerging middle-class and a working force that feels enough economic stability to purchase appliances, mobile phones and other consumer electronic goods. Furthermore, the Brazilian government is actively supporting and inviting investments from the electronics industry. The Growth Acceleration Project, approved in November 2007 by the Brazilian government, has US$3.5 billion allocated to it for "technology, science and innovation over three years"
(http://www.eetimes.com/showArticle.jhtml?articleID=206903317).

The above are all critical variables to consider when looking at Brazil, "the world's fifth-most populous country and the world's tenth-largest economy in GDP terms"
(http://www.economist.com/countries/brazil/profile.cfm?folder=Profile%2DEconomic%20Data).
While consumer spending remains strong and is set to continue at record breaking rates through Y2008, at least (Y2007 retail sales increased by 9.6%
(http://www.economist.com/agenda/displaystory.cfm?story_id=10925624)), there remain questions of whether or not domestic consumption can ever satisfy economies of scale necessary for local electronics manufacturing to be profitable. Current projections suggest that a significant amount of components and end-products (roughly 40 to 60 percent) would have to be exported to ensure profitability, were local manufacturing pursued more extensively.

Regardless of the projections by financial and industrial analysts, the Brazilian government recognizes the importance of a domestic high-tech industry for long-term economic success:

In a scenario of increasing technological sophistication, intensification of competition, acceleration of economic changes, and trade globalization, the need to prepare a high number of scientists, engineers, and other national professionals suitably qualified to understand, apply and innovate with changing scientific and technical bases is perhaps more pressing [for economic development (or economic stagnation)] now than ever. (Fatas-Villafranca, Fancisco, et al., 2008. "Modeling the co-evolution of national industries and institutions," in Industrial and Corporate Change 2008 17(1):66, Oxford University Press, http://icc.oxfordjournals.org/cgi/content/abstract/17/1/65)

And so the government investments and incentives are rightfully plentiful and shouldn't be overlooked by the strategically savvy corporation.

The Brazilian dream includes a healthy domestic semiconductor industry and the government is going a long way to ensure that dream becomes reality. Presently, the government backed programs are helping to establish a growing IC industry:

  • Fabs such as Ceitec's first CMOS semiconductor front-end manufacturing operation in Brazil which will begin production Spring 2008 using X-FAB's XC06 process technology ( EE Times Asia,www.eetasia.com/ART_8800493678_480200_NT_45f49c22.HTM),
  • Design centers/Electronic Design Automation (EDA) hubs (seven exist today and the goal is to have 15, the first one being Freescale's which has been there for 10 years, formerly under Motorola
    (http://www.eetimes.com/showArticle.jhtml?articleID=201807379);
    and the newest one being Cadence Design Systems' first of four design hubs that are planned to support the training of 1,500 new IC designers over a three-year period
    (www.eetimes.com/showArticle.jhtml?articleID=202800936),
  • IC assemblies (currently the only one is Smart Modular Technologies Inc.
    (http://www.eetimes.com/showArticle.jhtml?articleID=201805246));
  • Electronics Manufacturing Services (EMS) (the leading EMS companies have local operations: Benchmark Electronics, Sanmina-SCI, Foxconn, Flextronics, Jabil Circuit, and Elcoteq);
  • Original Equipment Manufacturers (OEMs) ("all the major computer OEMs and telecommunications companies, including Dell, IBM, Motorola and Nokia among others have production in Brazil, either operating their own factories or employing EMS providers"
    (www.purchasing.com/article/CA6499627.html); on May 8, 2008, as reported by Economic Daily News and DigiTimes, Compal's president Ray Chen announced plans to build a notebook computer plant in Brazil – initially focusing on repairs and ramping up to production later in the year
    (http://www.evertiq.com/news/read.do?news=11076&cat=4)).

Designing Reality
Despite significant steps in building a Brazilian semiconductor industry, critics are vociferous and point to important data that are not easily overlooked. Since 2003, over US$150 million has been invested in Ceitec, Brazil's front-end manufacturing line, yet critics still point out that the technology is dated and that it will take time and considerably greater efforts to build 'state-of-the-art' manufacturing sites, even for the local markets
(www.eetimes.com/showArticle.jhtml?articleID=206903317).

Yet analysts, such as iSuppli Corp., do predict significant growth for Brazil's EMS sector. According to Adam Pick, Principal Analyst EMS/ODM, iSuppli Corp., "[e]lectronics manufacturing activity in Brazil is expected to rise at a Compound Annual Growth Rate (CAGR) of 15.2 percent during the period from 2005 through 2011"
(www.emsnow.com/npps/story.cfm?id=25088). The reasons behind these optimistic forecasts go back to the initial variables that promote Brazil as an important locus for semiconductor growth due to its proven status as a BRIC nation, and as the leading emerging economy in all of Latin and South America. Brazil, therefore, ought to be considered a strategic investment for serving the Americas. Furthermore, "the export of Brazilian products is likely to increase to surrounding countries due to [Brazil's] participation in the South American free trade group known as MERCOSUR"
(
www.emsnow.com/npps/story.cfm?id=25088). Coupling these variables with the high Brazilian import tariffs (now averaging 15 percent, but declining) that are imposed on electronics in the face of soaring local consumer demand, those who forecast a medium- to long-term EMS success no longer seem out of step.

brazil

"Figure 1 presents iSuppli's forecast for Brazil's electronics contract manufacturing revenue for the period from 2005 through 2011"
( iSuppli Corp., February 2008 as cited in
www.emsnow.com/npps/story.cfm?id=25088).

 

Design is the uncontested shining star of Brazil’s future in the semiconductor industry. Brazil already houses seven design hubs, government allocations for an additional eight, plus private sector investments and new arrivals, government supported contracts for EDA tools to support the hubs, and an educational system that can contribute to the hubs (though only slowly at first); design is seen as Brazil’s true niche. The successes can already be counted and are growing: designs for Brazilian flex fuel cars (gasoline and local sugar cane bio-fuels), Brazilian digital TV (DTV) standard, local telecom chips for the booming mobile phone sector, as well as other local electronics products.

According to Manufacturing Market Insider (MMI), the global Original Design Manufacturers (ODMs) sector is poised to outpace the global EMS sector again for 2007 (MMI 18:3(p.5)). As the global growth in the ODM sector underscores, designs have a secure and inherent profitability (cf. "Co-evolution and Organic Growth: How OEMs are changing the EMS and ODM sectors," MarketWatch Quarterly, this issue). The promise of a successful and thriving design industry for Brazil becomes even more exciting when understood in terms of the important role that a secure foothold in the global high-tech marketplace can have for an emerging economy. The successful evolution of an emerging economy rests, in part, on the successful evolution of its domestic technological development. Thomas Hinderling, CEO of Centre Suisse d’Electronique et de Microelectronique (CSEM) offers, "if you look 30 or 50 years into the future, you certainly won’t find much semiconductor production in Europe, but you will still find chip design"
(www.eetimes.com/showArticle.jhtml?articleID=206903317).

Succeeding in emerging markets
As stated above, macroeconomic success for the emerging economy is directly linked to the successful development of its high-tech sector(s), among a number of other important variables. But there is more to realizing success in an emerging economy than simply having a keen strategist's eye for the moment of market convergence.

Certainly, the first strategic move when entering an emerging market is the recognition of the sector(s) that reveal the best opportunities for success aligning with core competencies of the firm. Whether to engage through new facilities investments, or through mergers and acquisitions (M&A), is often the first line of questioning. Interestingly, while M&A activity is typically reviewed from a short- to medium-term strategic and analytic perspective and "almost entirely based on the analysis of the consequences for shareholder value in the short term" (Nolan, Peter, et al. 2008, "The global business revolution, the cascade effect, and the challenge for firms from developing countries," in Cambridge Journal of Economics 32(1):33, Oxford University Press). Nolan, et al’s research reveals an important advantage to M&A for the long-term evaluation of the firm:

[…] well-selected and well-executed mergers and acquisitions that have a clear strategic purpose can increase the business capability of the firm concerned. They can strengthen the firm’s presence in given geographical markets, increase its access to technologies it formerly did not posses, acquire scarce human resources, add valuable brands to its portfolio, and enable long-term savings through economies of scale and scope in procurement, research and development and marketing. (ibid., p.33)

These academic findings, when listed this way become almost self-evident; they are echoed in the 2008 McKinsey Report, "How companies act on global trends: A McKinsey Global Survey"
(http://www.mckinseyquarterly.com/How_companies_act_on_global_
trends_A_McKinsey_Global_Survey_2130
).
The report underscores that while most firms are aware of global trends, translating this awareness into a successful business strategy that can be realized in the marketplace is more difficult than one might think.

In an earlier study from 2006, McKinsey offers a set of approaches for successfully overcoming some barriers to entering emerging economies and reaching the new consumer base ("A grassroots approach to emerging-market consumers"
http://www.mckinseyquarterly.com/A_grassroots_approach
_to_emerging-market_consumers_1866
).

Interestingly, while companies recognize the above stated advantages to M&A and recognize the opportunities available in emerging economies, there continue to be market events that impede the expected successes, such as:

  • Failure to present locally relevant products (i.e., lower-cost, specific features, socio-culturally sensitive product placement and marketing): "it becomes extremely important to deliver products and services in affordable parcels" (ibid., p.64);
  • Innovative and locally sensitive pay-per-use or collective-use billing and collection methods;
  • Recognizing the relationship between local social issues and corporate strategic success: "it might seem natural to describe community-based initiatives as a form of corporate social responsibility. Yet in most cases, the local initiatives actually make the business sustainable" (ibid., p.63);
  • Community-based cooperative programs for marketing and distributing the product(s);
  • Recognition of the state of the local infrastructure and the obstacles created as a result;
  • "The solution lies in the community. […] People in local communities […] are in the best position to help companies deal with the challenges of doing business in low-income areas" (ibid., p.66).

The McKinsey group recommends that long-term involvement in the individual communities in the emerging economies is central to "untangling a unique [company-community] problem" (ibid., p.61). The successful engagement with the local-community "may seem daunting […] [b]ut […] companies can tap into a huge growth opportunity for themselves and achieve competitive rates of return" (ibid., p.71).

Conclusion
The case of Brazil is one of exciting opportunities and significant growth levels. The data are very encouraging; so much so that both consumer end-markets and upstream business opportunities in Brazil should be considered by firms. While there are always risks inherent to entering emerging economies, there are also considerable data that can be employed to develop or refine appropriate and successful community- and corporate-based strategies.

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