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Luxury Brands Face Uncertain Future in Latin America

New free trade agreements could help boost the regional luxury market, but will they be enough to shield it from Covid-19 losses or be too controversial to benefit big markets like Brazil and Mexico?
Palacio de Hierro luxury department store in Polanco, Mexico City | Source: Shutterstock
  • Graciela Martin

SÃO PAULO, Brazil – As malls reopened this month in Brazil's largest cities, wealthy consumers were eager to get some retail therapy. Their new behaviour, however, suggests that shopping will never be the same again.

At Cidade Jardim luxury mall in São Paulo, stores finally reopened their doors on June 11 after 83 days of lockdown. Meanwhile, at the Catarina Fashion Outlet run by the mall’s parent company JHSF Participações, shoppers crowded the streets bringing traffic to a standstill. But the real big spenders were tucked away in Fazenda Boa Vista, an hour outside São Paulo, using WhatsApp to have jewellery and designer labels ferried out to them in the lavish resort community.

Interestingly, this month also saw Brazil’s Central Bank suspend WhatsApp’s new messenger payment feature which was being tested there. But even if the seamless payment function doesn’t return to the app, it won’t stop the wealthiest among WhatsApp’s 120 million Brazilian users from typing their orders out to personal shoppers to have luxury goods delivered to their country mansions.

JHSF is a favourite retailer of affluent Brazilians seeking anything from top tier brands like Gucci and Balmain to local names like Adriana Degreas and Alexandre Birman. Inside the mall group's posh stores, strict distancing rules were followed during the re-opening and shoppers were required to wear protective masks.

The personal luxury goods markets of Brazil, Mexico and Argentina are set to contract

Public health experts warn, however, that such measures may be insufficient to contain the pandemic. With over one million cases and fifty thousand deaths, Brazil's soaring coronavirus numbers give it the dubious distinction of being one of the worst hit countries — second only to the United States.

Still, President Jair Bolsonaro seems to be more concerned with the economic impact of the outbreak than the health crisis itself. More worrisome is that the coronavirus has not yet peaked in Brazil.

Regional Luxury Market to Contract

But Brazil is not alone. Covid-19 has been an unprecedented shock to all of the major markets where fashion and luxury brands invested in recent years: Mexico, Colombia, Chile, Peru and Argentina.

Shortly before the pandemic struck, Euromonitor forecasted that Latin America would be one of the fastest-growing luxury markets in the world, surging 9.1 percent from 2019 to 2020 — and that was despite major macroeconomic headwinds. The region's personal luxury goods market was worth $11 billion in 2019 and was set to reach $12 billion this year, with Mexico and Brazil in the lead at $4.7 billion and $3.4 billion, respectively.

Now, however, the immediate outlook is far more subdued. According to the latest Euromonitor projections, the personal luxury goods markets of Brazil, Mexico and Argentina are set to contract by approximately 6 percent, 4 percent and 3 percent respectively. This is a moderate decline compared to the US which is expected to contract by a staggering 25 percent. But as the full economic toll becomes clearer in the Latin American region, these figures could be revised.

Worryingly, the World Bank recently estimated that economic activity in Latin America and the Caribbean region will suffer the biggest drop of all global regions, at 7.2 percent of GDP. This combined with the extensive underlying political and economic instability that plague many of the key national markets understandably has luxury industry leaders worried.

"We noticed that [Brazil] was slow to give economic support to retailers, so we contributed capital to support our tenants in what we saw was our responsibility," said Carlos Jereissati Filho, chief executive of Iguatemi Group, in a recent interview with Brazilian newspaper Folha de Sao Paulo.

"If you consider the entire mall sector, there was an injection of a few billion [reais] for thousands of retailers renting those spaces, something that hasn't happened anywhere else in the world," added the businessman, whose nationwide network of luxury malls sells everything from Bottega Veneta to Chanel.  Both the Iguatemi Group and JHSF Participações suspended part or all of the rent for their tenants from March until May.

Clearly the region's luxury sector — like almost every other sector in the wider economy — is in a vulnerable state. So much so, in fact, that some of the big players are beginning to pine for a white knight to come to the rescue. Surprisingly perhaps, this may not be as farfetched as it seems, though in the unlikely form of a trade negotiator.

Free Trade to the Rescue?

There are now hopes that new or revised free trade agreements (FTAs) between countries in Latin America and the EU and US (which are the source of the majority of luxury goods imported into the region) could insulate the local luxury sector from some of the damage that the pandemic and global recession ultimately cause. According to one of the more bullish analysts, they might even boost consumption.

The [EU-Mercosur] agreement offers the only possibility for luxury brands to grow in double digits in Latin America.

"The [EU-Mercosur] agreement offers the only possibility for luxury brands to grow in double digits in Latin America. Few [other] regions have such growth potential [now]," said Miami-based Diego Stecchi, managing director at Luxury Retail Partners and former regional director of Ferragamo in Latin America.

Stecchi believes that the luxury sector in Latin America could experience growth by as much as 30 percent but that would be contingent on the opening of Mercosur, the trading bloc that includes Brazil, Argentina, Paraguay and Uruguay. "The growth [would] come primarily from duties elimination,” he said, pointing to stable or lower prices, repatriation of spending and new luxury brands entering or expanding in the region.

However, he stresses this would be only "theoretical potential" and that "it comes at a cost" pointing out that brands must have compelling local strategies and that markets like "Brazil still [have] a lot of corruption and poverty."

“It’s difficult to estimate how affected luxury will end up being in Latin America and when the markets will be able to get back to pre-Covid-19 levels, so I won’t speculate on different potential outcomes.”

A spokesperson from the European Commission confirmed that the deal between the EU and the Mercosur countries would cut tariff peaks of 35 percent down to zero on clothing and textiles, as part of a reciprocal arrangement. But it is important to note that this will not apply to accessories or other categories.

The EU-Mercosur FTA is just one of several trade deals under review across the region. Elsewhere, the EU-Mexico FTA could bring confidence to Mexico's business partners, according to Luis Huacuja, an academic and consultant in politics and international law, specialising in Mexico-EU Relations.

Timing Is Everything for Tariff Reform

Huacuja believes that the commercial part of the EU-Mexico agreement could come into effect within a year, at least provisionally, as it needs to be signed off by the European Parliament. In contrast, the opening of Mercosur requires the unanimous consent of all the EU members, which could take significantly longer.

"It is perhaps no coincidence that in the same week it was announced that there would be a newly revised deal between Mexico and the EU and that the US-Mexico-Canada (USMCA) agreement would become effective on July 1," said Huacuja.

The USMCA will mostly affect the automotive and farming sectors but revised rules on intellectual property, the internet, investment, state-owned enterprises, currency, and worker protection in Mexico, could bring some direct and indirect benefit to all consumer goods sectors and boost overall investor confidence.

Brands should maintain prices and not lower them to preserve their value in the eye of the consumer.

Meanwhile, the EU-Mexico agreement would continue to enable free trade on all non-farming goods which would include fashion products, as it was originally established in 2000. Stecchi believes it is for this reason that, "the agreement between Europe and Mercosur would be more important [to boost the luxury sector in Latin America] than [the agreement between] Mexico and Europe."

The new accord between Mexico and EU "will make it easier for European and Mexican firms to invest in each other's markets, including in the luxury sector," said a spokesperson from the European Commission.

Meanwhile, the EU-Mercosur deal now seems further out of reach as Bolsonaro's disregard for the Amazon rainforest has sparked a debate across Europe on whether to go ahead with the free trade agreement.

Last year, Brazil and the United Kingdom discussed an agreement similar to that of the European Union with Mercosur. However, John Price, managing director of Americas Market Intelligence, a consultancy firm specialising in the Latin American market, believes that "ahead of that agenda an agreement with the US is more important right now,” in part because of the close relationship between Donald Trump and Bolsonaro.

Bolsonaro’s controversial stance on a number of issues have also sufficiently irritated Trump opponents in Congress, making it increasingly unlikely that an agreement similar to the USMCA or even a mini-deal will happen in the near future.

Price Harmonisation and Currency Volatility

For those FTAs that do become ratified, any reduction of tariffs would offer some relief to the luxury sector. However, Paulo Chiele, director of PRC Luxury consultancy in São Paulo, believes that tariffs are "just a small component of what really influences pricing in the luxury goods sector; it's the local Brazilian taxes which make it costly to operate in the country."

Argentina and Chile have additional luxury taxes for manufacturers and consumers on certain luxury categories, including jewellery and fur. Moreover, Argentinian exchange controls limit and complicate access to foreign currency for international players.

"In Brazil some brands opted to equalise the prices to maintain their presence," explained Chiele. He cites the example of Gucci which decided to align Brazil prices with the United States. "They assumed the costs, but it did stimulate sales."

Stecchi believes that, even if an elimination of duties does come into effect, "costs will go down but brands should maintain prices and not lower them to preserve their value in the eye of the consumer."

Next year sales will increase again. Mexicans are very loyal to their brands and the brands trust the market.

Another factor complicating price harmonisation is currency volatility, which has long been an issue in the region. Now that the economy is particularly weak due to the pandemic, local currencies are even weaker than before.

While brands like Chanel and Louis Vuitton are raising prices on some products by around 5 percent in Europe to pad margins and to make up for revenue lost during weeks of imposed store closures, Mexico will see a stepper hike to compensate for the drop of the peso.

According to Latin American regional managers of European luxury brands, who spoke to BoF on the condition of anonymity, prices could rise by as much as 20 percent in Mexico and 10 to 15 percent in Brazil. Some will implement the price rise as soon as the stores reopen, while others will wait until the end of the year.

"If the [EU-Mercosur] agreement advances, something interesting could happen with the reduction of tariffs," said economist Nicolás Gadano, who in December stepped down as general manager of the Central Bank of Argentina.

However, Gadano explains that other issues need to be sorted out first to reap the accord’s benefits fully in Argentina. This includes lifting exchange controls, allowing access to imports and currency in addition to the restructuring of the public debt "which is still uncertain and taints the business and the financing of private companies."

Chasing Recovery Through E-Commerce and Repatriation

"Whether duties are eliminated or not… e-commerce has to be [the] number one [priority] for luxury brands looking to grow in Brazil [now]," said Stecchi. Indeed, during the health crisis digital channels have grown considerably and are expected to help consolidate the luxury sector in post-pandemic times.

"Quality always attracts the consumer and Brazil has already gone through many challenges and has huge potential for recovery," said Thiago Alonso de Oliveira, chief executive of JHSF Participações, the real estate firm behind Cidade Jardim in São Paulo and several other luxury shopping malls across Brazil.

"We are increasingly reinforcing the idea that the shopping centre can also go to the customer, wherever they are," says Olivera, referring to a new service launched after the pandemic called CJ em Casa, which is an interactive digital catalogue that allows customers to browse products and be immediately serviced by a personal shopper. The result, he says, is that some international brands only had a 10 percent drop in sales compared to the same period in the previous year because they continued to sell through WhatsApp.

"It has proved to be an important remote selling tool and we've decided to keep the catalogue forever in our portfolio, following changes in post-pandemic consumption habits."

Saks Mexico sales associates have also used WhatsApp to sell high-ticket items to their VIP customers offering interactive digital catalogues and customised digital events.

"Personalised attention is very important in Mexico. Customers form bonds with sales associates on a personal level. It's not a copy-paste script," says Katyna Quintana, who is in charge of customer relations at Sordo-Madaleno a real estate firm behind the development of some Mexico’s leading upscale shopping malls like Artz Pedregal in Mexico City and Luxury Hall in Puebla.

Quintana said that, although a decline is forecast for the luxury retail sector in Mexico this year, “next year sales will increase again. Mexicans are very loyal to their brands and the brands trust the market.”

According to Frank Sánchez, director of the European Institute of Luxury, luxury outposts in Mexico have one advantage in terms of the recovery. Speaking at a recent online event, he predicted that local clients will be more inclined to purchase at home since they are travelling less due to the pandemic and the devaluation of the peso.

The repatriation of spending back from Europe and the US to Latin American cities, will definitely increase said Fabian Hirose, a strategy & development management consultant for luxury brands operating in Asia and Latin America. "[But only] if brands know how to adapt the product [and strategies] for the Latin American market," he added.

"Latin Americans are over-spenders by nature, especially the luxury consumer. Otherwise, the experience is not that enjoyable for them,” said Hirose. "[So brands] know that even though the pandemic has [temporarily] affected the economy, [longterm] consumption patterns cannot be eradicated from a culture so easily."

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