Latin America – A Strategic Concern for the Chinese

China’s growth as the factory of the world requires ever increasing amounts of raw materials. Latin America has become a strategic source of raw materials for China's manufacturing process. It is also a supplier of agricultural goods to feed China's people.

This has led to an increasing involvement by the Chinese in Latin America's Economy. The Chinese government and its oil company, CNOOC, have invested US$400 million in gas exploration in Venezuela. China Minmetals Nonferrous Metals Co. has invested US$2 billion   in a joint venture with Chile’s state copper giant Codelco. Baoshan Iron and Steel has invested US$1.4 billion in a joint venture with Brazilian iron-ore giant CVRD  for the construction of a new steel plant in  Brazil. Yanguang Group has created a new coal company in Brazil in a joint venture with CVRD and Japan’s Itocho Corp. Chinese petrochemical corporation Sinopec has an alliance with Brazil's state oil company Petrobras.

The Chinese also are beginning to move higher into the supply chain itself. This is the next natural move. What is the point in investing in raw material if you cannot get it back to China quickly and profitably? Chinese and Korean companies are lobbying for a new Pacific freight port in Baja California at Punta Colonet. This is a US$1 billion   investment, aimed at reducing congestion at U.S. Pacific ports, and most importantly, at increasing the efficiencies of getting Chinese imports into the Americas.

As long as China wishes to maintain its economic growth rate, it will depend on raw materials from Latin America. This will drive commodity prices, which will remain strong through 2009, leading to strong currencies in South America. The influx of liquidity will continue upstream into the supply chain, galvanizing the logistics segments of the major Latin American countries.

Two Latin American countries take the lion’s share of economic activity. Brazil and Mexico amount to 72% of total Latin American GDP, and 68% of total population. Brazil and Mexico are large diversified economies. Brazil, with its 186 million people and Mexico with 107 million, also have large internal markets to bolster their domestic economies.

Mexico and Brazil are also the largest traders in the region. In 2007 Mexico exported upwards of US$185 billion  worth of goods, Brazil exported $96 billion , while imports for Mexico were US$197 billion , and US$63 billion  for Brazil. Trading is clearly an important part of the economy for both countries, and for Brazil, a huge foreign currency earner to the tune of US$33 billion .

Latin America also attracted $48 billion in foreign direct investment (FDI),   equity funds attracted US$4.5 billion, a nine-year record, with Brazil and Mexico taking the largest proportion. Remittances (money or goods sent home by migrant workers)  are also a huge money earner. Out of a total of US$60 billion of remittances going into the region, Mexico is getting US$30 billion, and Brazil US$6 billion in 2005. Latin American remittances already exceeded FDI figures by 26% back in 2003.

These figures pale in comparison to what China has promised Latin America. “In exchange for its access to raw materials and new markets, China promises to provide US$100 billion in investments in the region during the following decade.”. China has begun its investment to secure its share of raw materials. It has now come up against the same problem everybody has in Latin America – that of its logistics infrastructure.

Chronic under investment in infrastructure has reduced productivity and competitiveness.
Logistics costs are high because of inadequate transport infrastructure. Brazil could increase exports by US$25B annually if only it could implement logistics and customs modernization.

A look at Brazil gives an idea of the costs incurred by these logistics inefficiencies. Brazil’s logistics cost is 12.6% of gross domestic product  (GDP), while in the United States it is 8.2%. The difference of 4 points represents US$35 billion in terms of Brazilian GDP. This is almost as much as Brazil produces with its trade surplus. Reducing these inefficiencies by even a couple of points would still mean savings in the billions of dollars for Brazil.

Studies show that “a doubling of a country's transportation costs lead to a reduction in that country's trade by 80%.” “On average, each additional day that a product is delayed prior to being shipped reduces trade by a least 1%. Put differently, each day is equivalent to a country distancing itself from its trade partners by 70 kilometers on average…”

At present it takes 39 days for products leaving the factory to be exported from Brazil.
Mexico is slightly more efficient with 20 days. Brazil has the fourth most inefficient export and import system, just behind Bolivia, Colombia and El Salvador. In the US the average is 12 days

Clearly these inefficiencies are costly to Latin America, and it hits where it hurts most. Foreign trade is the way Latin America earns its foreign currency. For the Chinese, who have invested billions of dollars in procuring and securing raw material resources in Latin America, it is a huge constraint on getting their raw materials back to China. Their desire to reduce the impact of these bottlenecks is driving them to invest upstream, into logistics infrastructure and eventually into logistics companies. The opportunity for logistics process improvement companies and efficient logistics service providers is clear.

Latin American underinvestment in its logistics infrastructure is not new. What is new is that there is a motivated player in the market whose strategic interests are being hampered by the resulting inefficiencies. Significantly, this new player has hundreds of billions of dollars at its disposal, and is prepared to spend it to secure raw materials production assets and a supply chain to ship these resources back to China.

As the logistics segment moves up its maturity curve to ever more sophisticated service requirement and just-in-time-processes, the need for logistics process improvement companies and efficient logistics service providers become more acute. Mexico and Brazil are the most sophisticated and largest logistics markets in Latin America, but they have a long way to go compared with the United States.  

One of the early sign of increasing logistic sophistication is the outsourcing of logistics services to third-party providers. This is usually accompanied by a desire to reduce the number of logistics suppliers.  Both the shipper and the carrier can benefit from the greater efficiencies, cost reductions and quality of moving toward core competency specialization.

In Latin America consolidation has already occurred in Brazil and Mexico, Countries like Colombia, Chile and Argentina are not far behind, while the rest of the continent is still catching up. Research shows, that even in the top countries consolidation in both international and domestic carriers is still far from the ideal, and that companies are looking forward to greater efficiencies in their supply chains.

Other research supports this dynamic view of the Brazilian logistics environment.
Brazilian shippers are looking to reconfigure themselves for ever higher trading efficiencies. A study by Brazilian logistics specialists found that Brazilian international shippers are either planning or implementing changes in the way they manage their supply chains in  six major management categories.

If we look closer at the areas where they are planning these changes they mostly have to do with their capability to trade internationally. 34% of shippers say they are either planning or implementing changes in the way they ship internationally. 33% say they are implementing organizational changes to help them improve the way they ship internationally.

Some of these changes have to do with the changing customer environment, but in almost 40% of cases shippers are also implementing changes in their supplier base, and changes in distribution center configurations (26%). While 82% of Brazilian companies outsource the logistics of their international trade, only 31% are doing so with global suppliers. Global suppliers are more likely to be the more efficient and sophisticated companies, like UPS and FedEx. These companies are also connected to a global network of trade allowing them to offer lower prices, as they are able to spread their costs across a larger volume. Clearly the remaining 82% are using a fragmented base of much smaller carriers that are probably less efficient and maybe even more expensive to the shippers in the long run. There is a real opportunity for further consolidation in the market.
 
Brazilian companies in the logistics  segment have already realized their industry is going through rapid change. They realize there is growing interest from investors who see the needs and new potential of a market galvanized by the Chinese demand for raw materials and the resources to get these to port. They are not waiting and have already begun to invest heavily in their own capacities and efficiencies.

One notable company is America Latina Logistica (ALL): “Net profits of ALL have almost doubled up during 2006 first semester totaling R$98million against R$50 million reported last year.  Transported volume grew by 8.8% from January-June, achieving 9.268 billion tons. EBITDA rose 17.4% during the second quarter hitting R$164.8 million…”.

It has already attracted the attention of major Investment houses like Merrill Lynch; “In a research note …, the US investment house (Merrill Lynch), cited an  improved earnings outlook for ALL’s existing operations, and benefits from the possible acquisition of railway firm Brasil Ferrovias/Novoeste”, and; “Bear Sterns has raised its end-2006 price target for units in Brazilian logistics firm America Latina Logistica to R$264 from R$213 (US$1=R$2.142).”

U.S. process improvement enablers have already made major inroads into Mexico. Ferrocarril Mexicano is a private transportation company, formed by mainly Mexican capital (Grupo Mexico SA de CV) and by North American capital (Union Pacific Railroad), it was founded on February 1998, offering the cover area that extends from Mexico City to the cities of Gudalajara, Hermosillo, Monterrey and Chihuahua.

ALMER, a Mexican company that distributes grains and is a supplier of logistics services, hired for the second time RedPrairie’s services to improve their inventory management systems.

In conclusion, Mexico and Brazil are the largest markets in Latin America. Both present ample opportunities for global third-party logistics to improve logistics efficiencies. And both are now cash rich from commodity driven export income. These conditions will continue as long as China maintains its strategic imperative to grow its manufacturing capacity and to feed its population.

Sources:
 IMF World Economic Outlook, 2005
 UN Economic Commission for Latin America and the Caribbean, 2005
 Latin America's Chinese wake-up call, By Jose Orozco, Asia Times Oct 11 2006
 Source: Pimenta Lima Mauricio, CEL – do Coppead/UFRJ, “Custos Logísticos na Economica Brasileira”, January 2006
 Limao, N. and A.J. Venables (2001), “Infraestrcuture, Geogrphical Disadvantage and Transportation costs”; World Bank Economic Review 15
 Simeon Djankov, Caroline Freund, Cong S. Pham, May 2006, Trading on Time, World Bank Policy Research Working Paper 3909
 Copublication of the World Bank and the International Finance Corporation; “Doing Business in 2006: Creating jobs”; 2006
 CEL and COPPEAD, “Panorama Logístico: Relatório de Pesquisa”, 2005
 South American Business Information, August 15, 2006
 Agência Estado, May 9,2006
 Agência Estado, August 21, 2006

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