Entrance Strategy Brazil
Study for XX (XX)
..
M.R.M. Monninkhof
7-4-2009
Student nr: 1644467
1
stsupervisor: Dr. J. Kratzer
Preface
When I started my study at this University I never could have imagined what these two years would change me. I learned a lot, not only to study, but also to live the life like it is your very last day. I got the opportunity from XX to go abroad, to Colombia, with a tremendous assignment, to develop an entry strategy for XX to enter Brazil. First I was anxious, to go to a third world country, a land which is known for its terrorism? Even though I went, with mixed feelings.
Once there, everything was so different that I ever could have imagined. Bogotá, the main capital of Colombia was a metropolis with more than 8 million people, with skyscrapers, offices, shopping malls and so on. Furthermore, a great green country with tremendous panoramas, with tropical temperatures and snow on the tops of the highest peaks. The lunch culture, the dance culture and the great hospitality of even the poorest Colombians, living just a few yards away from a shopping mall. Also the nightlife was more developed that one could imagine, with clubs, bars , restaurants and whole nights of salsa dancing.
So I started my assignment in this great country and worked here with great pleasure. Unfortunately everything was too good to be true and something had to happen. In December I heard that my supervisor was kidnapped for several hours, just a few hundred yards from his apartment. As a consequence, I had to leave Colombia, because of safety issues. This came as a really big shock for me, because I had such a nice time in Colombia. Nevertheless, together with my supervisor we decided to finish my research in Curacao and on 5 January 2009 I left. Once relocated in Curacao, I found it much harder to work on my project because I wasn’t close the source anymore. However, I managed it while I am writing this preface in my final days at Curaçao. I am proud of the final result and I am looking back at a great time of work and pleasure.
Of course I wasn’t able to do this without the help of many of my colleagues/friends and family, especially: • William Veldman, with who I had a really good time and from who I had the most support. All the discussion which I had helped the quality of this research to get to another level. • Raymonde de Wagemaker, President of XX Americas, who really was a pioneer for my research. With all his insights, experience and knowledge he shared with me I am really great full. • Ton van Opstal, Financial Director of XX Americas, who was a great help for many of my questions. Financial or non‐financial, we had often great discussions during the lunch.
Management Summary
The most difficult barriers to cross are established by the Brazilian government and Petrobras. Brazil’s government is dominated by government labor unions, which found a way to protect its workers directly in the Brazilian Constitution. Their presence creates folds and folds of bureaucracy, and consequently everything having to do with the government is difficult and labor intense. Brazil was listed number 122 of 178 economies in a World Bank report. It takes a little more than six months to open a business in Brazil, which means that it takes less time in India. Setting up an new business in Brazil is very complicated, but once it is open, a business has enormous labor benefits which can almost duplicate salary costs.
difficult
Once a new business is created, doing business in Brazil is easier said than done and is time consuming. Environmental licenses are almost arbitrarily determined. Capital investments are taxed, and there are many restraints against foreign investors taking profits out of the country. Equally worrying is that Petrobras heavily protects national companies. Without representation in Brazil, no company can offer services to Petrobras. It has established a bureaucratic bidding process for its contracts, which can be appealed multiple times by displeased bidders and held up for an indefinite amount of time.
I analyzed all of these difficulties, and still, undoubtedly believe that Brazil is an excellent investment opportunity. All investments have some barriers, and indeed without risk there would be little rewards. However, the question still remains “if entering brazil by an acquisition is a feasible and good solution”.
When taking all mentioned points in consideration for XX, it can be concluded that If XX wants to enter Brazil successful, without many complications and losing time as in laws and regulations of the government, without liabilities of newness and foreignness, entering Brazil by Acquisition is a feasible and first‐class solution.
Entering a foreign Country Importance in %
Company 1 Company 2 Company 3
Market Knowledge/Access 15
Culture 15
Complementarity of Capabilities/ Compatibility
10
Growth Potential 10
Managerial Capabilities 10
Capabilities to Provide Quality Product/Service 10 Intangible assets 10 Financial 10 Technical Capabilities 5 Previous Alliance Experience 5 Total 100
This general framework will be filled in for the selected companies who came through the first screening, which is based on the market analysis. In this framework the 5‐point Likert scale is used, where 5 points are the highest/best amount and 0 point the lowest/worst. These numbers will be multiplied by the relative weight of each objective. The total summation than will make the company with the highest outcome the best candidate for acquisition.
Due to the mandatory move to Curacao and a lack of time it was not possible to fulfill the whole process in search for the right partner for XX. The search for a good partner for XX can start with a database of 1,500 companies, provided by the National Organization of the Petroleum Industry (ONIP). This database can be the input for the developed selection tool which will carry on the best partner to acquire for XX.
Finally the addendums contain much information that I wanted to include in the body of the report, but because of space limitations were unable. There are addendums with information concerning Petrobras’ bidding and appeal process, information on the steps to open a business, labor issues and corporate laws. The recommendation according the entry strategy in this report will be a great second step for XX to further consolidate their goals in the Latin American market.
Chapter 1 Problem identification
This chapter will start with an introduction of the company and a background of the organization. After that the problem of the organization and the objectives of this research will be discussed. Furthermore the methodology which will be in this used in this thesis and the theoretical framework. 1.1. Organization XX 1.2. Problem XX wants to expand in Latin America. Currently they have bought the company OO in Colombia from where they presently operate. Their goal is to grow to a turnover of 500 million US$ in the region. To realize that, they want to expand in Brazil. However, Brazil is a dangerous market to the foreign investor because it ‘s very different from all other markets. Therefore, the Brazilian market has to be investigated for potential save investments, strategy to entrance, etc. Persons involved The researcher and the president of XX Americas will play a dominant role in this research. Also the main management team of XX will play an important role. Interests of the people involved 1. The researcher has to finish this study before February
2. The management of XX wants to focus the investigation on the Brazilian Oil and Gas maintenance service. 1.3. Objectives Giving the management of XX advice: • Determine if Brazil is a market in which XX should invest; • Determine key groups (competitors, possible partners, providers, clients) in the Brazilian Oil and Gas industry;
• Determine an Entrance Strategy for XX in the Brazilian Market (Link in the value chain, Partnership, and Porter’s forces model).
1.4. Methodology
All research problems entail their own approaches. Since every research problem is unique in some ways, the research procedure is typically customized. This research will contribute especially to the practice of the management of XX, since this research focuses on entering Brazil. The problem will be indentified within XX and literature will be used to support the content of the problem and finally find a well stated solution for this problem.
For this research it is of great interest to systematically structure the analysis of the internal and external environment. This research will use the following structure. Firstly the problem will be discussed. Secondly the internal environment of XX will be diagnosed. After that the external environment will be analyzed by the DESTEP analysis. This will be followed up by an analysis of the Brazilian Oil and Gas industry which will be executed by the 5 forces model of Porter. After this the main question will be answered, if entering Brazil by by an acquisition is a feasible and good solution. This information will be presented to the board of XX and will be followed up by a recommendation.
1.5. Theoretical Framework
A company can decide to enter a new country in different ways. According to Holger (2000) and Slangen ea. (2008), to enter the Brazilian market, XX has two possible entry modes; to go Greenfield or by an Acquisition. To enter a market by Greenfield means that a company will start up a company from zero. However, entering by Acquisition means taking over a part or the whole company which is already settled in the foreign country. Both methods have their own pros and cons which in each case must be considered what the best possible solution is and will be analyzed.
According to Buckly and Casson (1998) market knowledge is very important when discussing the choice between greenfield and acquisition. E.g. entry by greenfield increases local capacity and intensifies competition whereas entry by acquisition does not. To gain market knowledge, to have enough information to focus on an entry strategy, external and internal analysis’ have to be executed.
A research of the external environment in a country can be executed by different models and theories. In this research it is necessary to analyze Brazil as a country in general and the field in which XX want to be active namely, the oil and gas industry. Therefore two well known models will be used. The DESTEP analyses will be used to analyze the external environment of Brazil and the five forces model of porter to analyze industry itself, the oil and gas market. External analysis of Brazil (Macro)
The Macro environment is the external environment in which a company is active, but were the company cannot control it’s factors (Demographic, Economical, Social, Technological, Ecological and Political). The DESTEP analysis is a good method to structure and analyze the external environment of a new country, in this case Brazil. It is a tool which will be used to structure all the important external factors when entering a new country. The data collection to fill in this model will be gained out of desk research.
Industry analysis
The industry analysis is the external environment in which a company is active, however were it could influence its factors, i.e. competitors, suppliers, customers etc. According to Porter (1985) the five forces model can be used to analyze the industrial market environment. This model will be used to analyze the Brazilian Oil and Gas industry. Meetings Furthermore data will be collected from the following important persons through meetings: • Key members of XX Industry Services • Key members of the Oil and Gas Industry in Brazil • Future XX clients and competitors Desk research
Every research will require a document analysis, gathering information in an academic way which shows awareness of the current state of knowledge on the subject (Gill & Jonhson, 2006). In order to conduct this, numerous sources of academic literature have been checked in order to perform this research. Thereby market studies and many major consulting companies and institutes have been used e.g. OPEC, CIA factbook, marketwatch, BP, and many more. Furthermore, annual reports of XX have been analyzed and company websites. For the first two methods the ‘snowball’ method has been used. This manner entails using relevant literature, tracing of references (Aken, 2007). To accomplish this, several search engines have been used, e.g. business source premier and XX sharepoint (in which many annual reports and trustful company information was gathered).
Reliability and Validity
According to Aken (2007) there are several methods to evaluate a business problem. The most important criteria are reliability and validity. Below these criteria are described.
Reliability
Especially in a qualitative research reliability is difficult to measure. There are four biases which influences the reliability of a research: the researcher, the instrument, the respondents and the situation. The same study by another researcher, with the use of different methods, with different people and other situations, should have the same results (Aken, 2007). If another person should do this research it probably will have the same outcome. The methods used and the information gathered are all from reliable and academic sources or institutes.
Validity
Another important criteria in solving business problems is validity. A result is called valid when it is justified by the way it is generated (Aken, 2007). Validity refers to the relationship between a research result or conclusion and the way it has been generated. According to Aken (2007) there are three types of validity which are important by solving business problems: construct, internal and external validity. Construct validity means if an instrument measures what it is projected to measure, this can be done via the student or other experts. This study is evaluated experts of XX and the supervisors from the University.
Internal Validity is the approximate truth about inferences regarding cause‐effect or causal relationships. Thus, internal validity is only relevant in studies that try to establish a causal relationship. In this research internal validity is low because of the lack of causal relations.
External validity refers to the question if the research and conclusion are useful for other people, organizations, countries and situations. This research is specially executed for XX and is classified, however for competitors, and other companies active in or willing to enter Brazils oil and gas market, this research could be useful.
Main question
To define which entry strategy for XX is the best option both strategies have to be investigated. However, because of the large scope of this research I choose to investigate the Acquisition side, another researcher will investigate the Greenfield‐entrance strategy. According to Holger (2000) and Slangen ea. (2008) there are two main entrance strategies for XX to enter Brazil. • Greenfield • Acquisition I will investigate if entering Brazil by Acquisition is a feasible and good solution
Both options can give a positive recommendation, but it is also possible that one solution will be recommended, another outcome can be that entering Brazil for XX is for example to difficult and expensive which can be result for both thesis’s to not enter Brazil.
Chapter 2 Analysis of XX
To gain market knowledge, to have enough information to focus on an entry strategy, external and internal analysis’ have to be executed. This chapter will analyze XX, an analysis will be made about the whole company. It will start with an introduction, followed by the products, market segment in which XX operates, the geography , finance and will end up with a conclusion. 2.1. Introduction XX (XX) is owned by the XX BV holding company from The Netherlands which is part of Candover. XX BV is a Dutch manufacturing and service providing company with its headquarters in Naarden, founded in 1868 by Charles Theodoor XX. XX has four operating companies which have developed or purchased 82 operating companies through the world: XX Prints, XX Food Systems, XX Aerospace, and XX Technical Services. XX is part of XX Technical Services, and it specializes, but is not limited to, the Oil and Gas Industry. XX is a provider of Services in Construction and Project Management, General Maintenance, Maintenance Management, and Equipment Rentals for the Oil and Gas Industries in Aruba, Dutch Antilles, Trinidad & Tobago, Surinam, Colombia and Argentina. It specializes in providing complete solutions for all stages in planning, management and implementation of new construction projects. It also provides services in Industrial Installation Facility turnaround, revamp and relocation. This can also include regular inspections of the Facility, with preventive maintenance, repairs, measurements and problem solving, all onshore and offshore, 24 hours a day. XX can place on‐site Maintenance managers, who can be integrated directly into the management of the production facility. This is done to provide “continuous improvements in total production,” which can be implemented more quickly, and provide “measurable added value” and problem solving. XX is a part of a worldwide network of companies providing Technical Services, and benefits from the experience and size of this conglomerated knowledge. Jan Bruggenthijs, managing director of XX Industry Services:“Because we carry out maintenance in many different locations and for many different companies, we can also create synergies. For example you might be able to solve a problem in the oil and gas industry by using something that was developed for the maintenance of an aircraft. We use a data gathering system to enable us to share our knowledge. Everything that we develop is stored centrally, and is available to all our managers and engineers” 1 XX Technical Services sees itself as an integrated partner for its clients, searching for better ways to make Industrial Facilities more efficient and cost effective. It is a “basic principle to ensure maximum availability of installations/machines at transparent (lowest possible) costs per unit of product through the entire lifecycle of the installation/machine”.2
History
Mission, Vision, and Values
XX’s mission statement published in its website states:
“Maximize availability and performance of Clients' production facilities at the most efficient maintenance cost level.” Deliver this by: • Integrated services contracting (ISC) • Management expertise (Asset, Contract, Project, Operations, Maintenance, Modifications) • Maintenance service and departments (24/7) • Deployment of professionals and motivated specialists • Regional presence with central knowledge and expertise XX’s Vision is clearly more focused on its clients than it is on itself: “Our clients have fewer problems and get better results with XX s as a long term partner.” This is also evident in its Core Values: • Safety first • Client focus • One recognizable Company • Open, transparent, integrity • Joy and pride • Not the effort but the result is being rewarded • Ask help, give help 2.2. Products and Services
XX provides Technical Services for the Oil and Gas Industry from complete Production Facilities to individual machines. These services include: Construction and Project Management, General Maintenance Services, Maintenance Management, Equipment, Rentals, and other Specialized Services. If a service is not available directly from its organization, XX will subcontract from other companies, providing their customers a seamless option of services. In some cases, as the payment of the Service Contract can be delayed to different points in the progress of a project, XX provides some finance for its clients.
Sales
Construction represents the largest percentage of its sales, followed by General Maintenance. Maintenance Management is relatively new in Latin America, while it is the norm in the European market. Jan Bruggenthijs, managing director of XX Industry Services:
“Maintenance demands a different approach to the customer, as well as a different methodology. That’s why we’ve made big investments in maintenance management, as a result of which we’ve developed the skills to advise the customer about how he can best organize the maintenance process. We always share the aim of increasing the availability of an installation and reducing the maintenance costs”
It is believed that this particular service, once the practice of subcontracting in Latin America becomes more common, will represent a much more important percentage of its Gross Sales.
Source: MCP Colombia Group 2007 2.3. Contracts
XX’s services are provided to its clients via contracts. There are four types of contracts: lump‐sum, cost‐plus, unit price per activity, and unit price per manpower. Contract break down over the last five years shows a great preference for Lump‐Sum contracts, which provide the client certainty of costs. This financing is assumed by XX and provided by the holding company XX NV. Source: MCP Colombia Group 2007 Maintenance Contracts are usually yearly and include labor hours and materials. Payments are made when a project is delivered. 2.4. Market Segment
XX’s clients are in the Oil, Gas and Petrochemical Industry and include companies like Amoco, BP, NAM, Shell, TotalFinaElf, Valero Aruba Refining Company and the Arabian Water and Electricity Company (WEB). The usual XX client is searching for an outsourcing option to the complexities of managing an oil and gas industrial facility. As a whole, the Industry clients are focusing more on their core activities and searching for specialists to provide their operational needs. As Managing Director Jan Bruggenthijs explains:
XX provides: • An Industrial group with strong brand name within the industry • A Triple A customer base • A long standing record of innovation • Technological drive • Operational excellence • Sustained financial performance • Coupled with a human resource pool which excels in managing mature businesses 2.5. Geography XX has representation in six countries in the Caribbean and Latin America. Its first office was opened in Aruba in 1965, with Exxon as its primary client. A few years later it then expanded into Curacao, as the principal contractor for the Shell refinery in the island. In 2005, XX established itself in Trinidad & Tobago with XX Elecon Ltd. and XX Damus Tecnoconsult Maintenance Management Group. Most recently, XX acquired Mecánicos Asociados S.A. (OO) in Bogotá (in 2007), Colombia as an entry point into Latin America. Most of the companies in the Caribbean have a limited number of services available directly XX, however with its worldwide network of companies, it can provide any service in any market.
2.7. Marketing Promotion The most effective forms of marketing in Maintenance and Services for the Oil and Gas Industry are having a reputation for quality work and word of mouth references. It is mostly a customer led sale, and as such, publicity is uncommon in the industry. Prospective clients may be approached directly by the General Manager, providing a company profile sheet, presenting technical information about the company, such as its products, services, history of executed projects, and the equipment that is available to the client. The company profile emphasizes a high‐level of professional work, excellent management skills and special services afforded to the company by its relation to XX NV. Other qualities used in their promotion are: • In‐depth knowledge of integrated maintenance management concepts for industrial customers • Strong customer and site‐intimacy • Performance based integrated service contracts with first class customers • Unique asset improvement consultancy within XX Maintenance Management • Unique knowledge of process management for progress and budget monitoring • Joint responsibility with customer for optimizing total cost of ownership • Specialist knowledge of equipment, components and technology.
Another highly effective means of promotion is the XX website, which provides information about the company, as well as direct contact links. Brand visibility is also accomplished with uniforms, helmets, and trucks brandishing the company logo.
Pricing Policy
Their positioning in the market is to develop long‐term partnerships with their clients, providing high quality, transparent and efficient service that will reduce costs and increase productivity. In some cases, to comply with this guarantee, XX will only make a profit if their work is completed on time and within budget constraints. Managing Director Jan Bruggenthijs explains:
Bidding process
Many projects in different countries, particularly those developed by government institutions, are determined by a Bidding Process, limited to companies that have passed a screening process and have received a certification as an authorized Provider for the Government. Participating in these bids is decided by determining the opportunities, the risks and the location. The role of a XX operating company in the bid is flexible, as it can be a complete service provider, a partial service provider, or as a subcontractor in charge of Management for the Project.
2.8. Finance XX BV
In the XX industry services there has been improvement in turnover and number of orders received. There has been a completion of important contracts (€5millions) and an acquisition of new ones (€7millions).
Turnover increased 21% and the operating results a 36% with respect to 2007. These results are consequences of a growing market, particularly the Oil & Gas sector, and several acquisitions in niche markets with room for consolidation. The market has grown 2 ‐ 4% and continues to develop positively.
The capital structure has been adjusted during the past years. There has been a return of funds to shareholders (capital return of € 130 mln and share buyback of € 70 mln) keeping a right balance to maintain financial flexibility for future acquisitions. Earnings before interest and taxes in the third quarter decreased on 36% for XX N.V., but the Technical Services unit had a remarkable development, increasing their earnings in €3.2 mln. with respect to 2007.
XX s
The financial information for Store was provided by Ton van Opstal, Finance Controller for XX. Reviewing the financial indicators, immediate attention is brought to the change in Cash, EBIT (2008), Working Capital (Net and Gross), Invested Capital, and Items related to Operations, while XX has other standards than OO. These changes were probably brought about by the increase in investments, particularly in assets and operations. Possibly the investment in OO is reflected in these changes. As well, these changes could also be explained by the market they operate in, particularly where a new contract can represent a considerable upfront investment, with yearly incomes based on completion of the contract.
Analyzing the resulting ratios, the company has a large “Turnover of total operating assets”, indicating high assts investment versus total sales. Again, this is possibly a result of recent investments. 2007 recorded an increase of 192% in sales, which were not duplicated in 2008. Sales curved in, but still nearly doublings sales for 2006.
2.9. Summary
XX (XX) is 100% owned by the XX BV holding company from the Netherlands which is part of Candover. XX is part of XX Technical Services, and it specializes, but is not limited to the Oil and Gas Industry. XX is active in Aruba, Dutch Antilles, Trinidad & Tobago, Surinam, Colombia and Argentina. The management team is composed of the managing director and controller of XX, and the three general managers of XX Wescar Aruba NV, XX Wescar NV and XX Elecon Ltc. XX’s independent operating companies report to XX’s managing director and controller.
XX’s Mission:“Maximize availability and performance of Clients’ production facilities at the most efficient maintenance level.”
The vision is clearly more focused on its client than it is with itself:
XX’s Vission: “Our clients have fewer problems and get better result with XX s as a long term partner.”
XX’s clients are in the Oil, Gas and Petrochemical Industry and include companies like, Amoco, BP, NAM, Shell, TotalFinaElf, Valera Aruba Refining Company and the Aruban Water and Electricity Company (WEB). XX has representation in six countries in the Caribbean and Latin America. Most recently, XX acquired Mecanicos Asociados S.A. (OO) in Bogota, as an entry point into Latin America.
The most effective forms of marketing in maintenance and services for the oil and gas industry are having a reputation for quality work and word of mouth references. Their positioning in the market is to develop long‐term partnerships with their clients and in some cases XX will only make profit if their work is completed on time and within budget constraints. However in this way, clients have fewer problems and get better results with XX s as a long term partner.
Chapter 3 Macro Analysis of Brazil
To gain market knowledge, to have enough information to focus on an entrance strategy, internal and external analysis have to be executed. After the internal analysis of XX in Chapter 2, the Macro environment can be analyzed, the environment in which a XX is active. XX cannot control these factors, nor influence them. In this research it is necessary to analyze Brazil as country in general. To structure and to analyze the external environment of XX the DESTEP analysis can be used, to lead the external analysis by a systematically approach via six clearly defined aspects. It is a tool which will be used to structure all the important external factors when entering a new country, so that all these factors will be taking into account to come to a correct strategy. These six factors are: Demographic, Economical, Social, Technological, Ecological and Political.
Systematically from several perspectives the surroundings are mapped to penetrate the impact on the system:
• Demographic (age structure, demographic ageing, religions) gives a better view where it is about in the system.
• Ecological (environmental impact, climate) indicates frequently the boundary conditions and external factors. Ecological factors can influence slowly but also influence the system abruptly. A quantification is a possible, but frequently an costly activity. • Social factors (standards and values, feelings in the society, crime,) indicate strengths within a system. Social factors are retrieved frequently with interactive and creative sessions.
• Technologic (technical progress, communication, energy) gives the possibilities to, which can change sometimes abruptly a system serious. • Economic (competition, economic climate, market development, currency, inflation) frequently plays a dominant role. • Political (Legislation, political climate, degree of government intervention, policy) frequently has a large influence on the system design. 5 3.1. Demographic Analysis
The age structure was equally divided between males and females till the age of 64 years. 27.0 % of the population was between the 0 and 14 years old (male 27 million/female 26 million) 68,8 % of the population was between the 15‐64 years old (male 65 million /female 66 million). The last but not least group from 65 years and over counts only for 6,3 % and is not equally dived anymore (male 5 million /female 7 million)
The religions are: Roman Catholic (nominal) 73.6%, Protestant 15.4%, Spiritualist 1.3%, Bantu/voodoo 0.3%, other 1.8%, unspecified 0.2%, none 7.4%.7 3.2. Economic Analysis Production and Employment In 2007 and through to October of 2008, the Brazilian economy has experienced a growth of 3,7% and 4,7%, respectively, in its Gross Domestic Product. These numbers are somewhat poorer to the growth experienced in the region as a whole.
The largest production sectors in 2007 are Service (55%GDP), Industry (26%GDP) and Agriculture (4%GDP). The Service sector experienced an increase of 3,7% for the year, with a particular emphasis in financial institutions (+4.3%) and transport (+3.2%). The growth in the Industrial sector is explained by an increase in the extraction of iron (+6%) and petroleum (+5.6%)8. The Agricultural sector had an increase of 4,1%, this is due to an increase in productivity (8.4%), allowing for a reduction (4,4%) in harvested land.
The open unemployment rate in 2007 was 10%, similar to 2006, as well as what is anticipated in 2008. Commerce and the Industrial and Service Sectors accounted for 520,000 new jobs. This has helped increase the formal employment rate, but cause scarcity in qualified human recourses, which may be a bottleneck in reaching high production numbers. This has caused an overheating in salaries, and increased operating costs for companies.
Key Industries
the oil ever discovered in Brazil. Initial production should exceed 100,000 barrels a day. Presidential Chief of Staff, Dilma Rousseff, described the discovery as “changing our reality to another level, like Venezuela, Arab nations and others.” 10.
The Brazilian Oil Industry is regulated by the Petroleum National Agency, and depends on the Ministry of Mines and Energy. Since 1997, the Industry was deregulated, and now 17 companies compete, with Petróleo Ipiranga being the second largest national company producing sales of U$11.6 billion. However, Petrobras still controls over 90% of Brazil’s oil production and retains a monopoly on the wholesale market for oil derivatives. It owns around one‐third of Brazil’s pipelines and distribution terminals for petroleum, as well as 16 refineries and over 7,000 service stations. It has developed alliances with Repsol‐YPF (Spain), ExxonMobil (US), Shell (UK), BP (UK), ChevronTexaco (US) and Total (France) to facilitate access to capital, provide technology transfer and share risk. Petrobras has stepped up its investment plans and its two main priorities will be boosting refinery capacity and producing natural gas with a view to attaining self‐sufficiency11.
In the last three years, Petrobras has received a record volume of investments: US$20,9 billion, of which US$11,68 billion correspond to 2006 alone. Another US$17,27 billion are expected in 2007. As well, on February 18, 2006 record profits of US$10,77 billion were announced. This was not only a company record, but a record for all privately‐owned companies in Latin America. In the next five years Petrobras will invest US$ 50 billion in exploration and refineries, increasing their output 54%, as their petroleum exports will increase 190% and their imports will decrease 65%. This growth in investments will create a total of 419,000 new jobs (160,000 direct)12. Inflation In 2007 the inflation was the lowest in a decade for Brazil (3.14%), as well as the lowest in the region. The targeted inflation range in 2007 is 4.5% (+/‐ 2%), and in the first half of the year, this range has been successfully met. The Economist has prognosticated an Inflation of 3.5% in the end 2009 and of 3.6% in 2010. Some implications of Inflation Targeting are seen in the stability of its Macro‐economy, with the slow growth in the GDP, high interest rates, and appreciating currency, as well as a high Primary Surplus. The appreciating Real, which is encouraging growth in imports, will prevent an accelerating domestic demand from creating higher inflationary pressures.
Exchange Rate
equivalent of the sum of the rate of growth of the GDP (the next to last year) and the increase in the National Consumer Price Index (the last year). The growth in Wages for 2008 is expected to be 3.6%, and 4.0% in 2009.14 3.3. Social Analysis Brazil’s population is unfairly distributed across the regions. The wealthiest region, encompassing the states of São Paulo, Rio de Janeiro, Minas Gerais and Espírito Santo, accounts for over one‐half of Brazil’s GDP. Manufacturing is concentrated in the state of São Paulo. After a long period of decline, the state of Rio de Janeiro has recovered in recent years, boosted by oil development, where Petrobras is based. Fourteen cities, including the federal capital, Brasilia, now have a population of over 1 million citizens.
Although income inequality is a problem, increases in the minimum wage, combined with anti‐ poverty programs, like Bolsa Família, have had a significant effect in distribution of wealth. The level of crime in Brazil’s major cities is high, particularly in the two largest, São Paulo and Rio de Janeiro. Absence of the security forces underpin concerns about the ability to contain the problem. Sporadic conflicts between security forces and armed gangs have the potential to spread panic and disruption among the population. A 3,000‐strong federal security force has been deployed in Rio de Janeiro since January 2007 to restore order following an escalation in violence. Organized criminal groups are involved in robbing cargo from shipments, with incidents concentrated in São Paulo and Rio de Janeiro states.
3.4. Technology Analysis Transportation
Brazil’s transportation infrastructure is below the curve of other countries with similar economic development. Investment by the Ministry of Transport accounted for only 0.23% of GDP in 2006, with only 12.5% of existing roads are cemented. This situation stands even though roads are the most common means of transportation, with nearly 60% of freight transported through the road system, and Brazil’s enormous geographical extension. Rail or waterway transportation is underdeveloped, even though it is significantly cheaper. Airline deregulations have brought price reductions in Air Cargo and now more than 150 cities have direct access, but it is still comparatively expensive.
Communication
As in most of the world, privatizations and liberalization in the 1990s attracted major inflows of private investment into the telecommunications sector. Mobile‐phone penetration overtook fixed lines in 2003. Cheaper mobile technology has become the major driver of increased telephony penetration among low income users.
Energy
Since 1975 Brazil has used multiple sources of fuel for its transportation: petroleum, ethanol, and liquid gas. This diversification was a result of high petroleum prices, and it is unique in the region. As the world searches for alternate fuels, Brazil is a leader in ethanol production, and in 2005, in a joint venture with Alcohol Nippon Hanbai, started exporting to Japan. In 2007, renewable sources of energy represented 45% of total provision compared with the world average of 14%. In recent years, the use of sugar cane alcohol (ethanol) as a source of power has intensified. The share of gas in the energy grid has increased to more than 9% following the launch of the pipeline that links Bolivia and the south of Brazil in 1999. In 2006, Lula’s government has tried to reduce dependency on Bolivia’s gas and has announced plans to set up at least two plants to process liquefied natural gas. 3.5. Ecological Analysis Brazil is a world leader in the use of renewable energy sources, namely hydroelectricity and ethanol. Nonetheless, rapid urbanization has contributed to high levels of pollution in major cities, where gases emitted by vehicles and industry often reach dangerous levels. The Amazon forest and Brazil’s temperate forests are under threat from the expansion of forestry, farming and mining. Over the last 30 years of the 20th century around one seventh of the Amazon’s forested area was lost. The rate of deforestation has tended to decline in Brazil in recent years. 3.6. Political Analysis Executive and Legislative Branches The re‐election of president Luiz Inácio Lula da Silva, “Lula”, from the Partido dos Trabalhadores (PT), was a step further in the process of democratic consolidation, started at the end of the military rule in 1985. Greater macroeconomic stability achieved during Lula’s first administration, owing to the maintenance of orthodox expenditure policies, permitted an increased importance on anti‐poverty initiatives. This boosted Lula’s popularity despite a vote‐buying scandal that emerged in 2005, damaging the PT’s reputation.
Taxes And Labor Laws
Brazil’s complex tax structure affects its competitiveness, and the constitutional obligation on the administration to make heavy transfers to states and city continues to be an obstacle to federal control of fiscal management. The new national accounts’ methodology showed that the average ratio of investment to GDP in Brazil has been even lower than previously estimated (16.4% in 2000‐ 07 against 17‐19%), slowing down the expansion of industrial capacity and resulting in high costs and bottlenecks in infrastructure services. Other factors contributing to the high business costs that slow down competitiveness and constrain investment, known as Custo Brasil, are a burdensome tax regime, restrictive labor laws, a costly and slow judicial system. An indepth break down of taxes in Brazil, both Corporate and Individual, can be found in Addendum X. Labor laws will be developed in the Suppliers analysis. 3.7. Conclusion
Brazil is a really big county with almost 200 million inhabitants. Despite the fact that the crime in major cities is high, due to government acts Brazil is restoring order with a strong federal security force. Brazil’s macroeconomic indicators show a great deal of stability and growth, particularly in the petroleum industry. The discovery of new oil wells is helping Brazil become far more independent against the international market. Brazil’s vulnerability has been greatly limited by this independence, and companies investing in this industry can take advantage of its growth, especially because there have not been enough companies to manage the quantity of work. However, considering the Industry’s concentration and Petrobras’ market power, service providers must be aware of this limitation, and be able to adapt to its requirement. The added growth of ethanol as an export product is further expanding the industry, adding even more investment opportunities in providing services. Moreover Brazil shows difficult established barriers to cross by the Brazilian government and Peterobras, while it takes more than six months to open a business in Brazil. Next to the government, Petrobras has many bureaucratic rules to handle, however once there is a relationship, it can be extremely profitable.
Chapter 4 Brazilian COG (Chemical Oil Gas) Industry Analysis
After analyzing XX itself and the macro environment with the DESTEP analysis the industry of XX is important. The field in which XX wants to be active namely, the oil and gas industry. The 5 forces model of Porter is used to analyze this industry.
4.1. Substitute products
For Oil Companies, the perfect substitute to contracting a Service and Maintenance Company to service their assets is to create an in‐house maintenance team. Developing their own team of experts and their own manual of procedures would make it unnecessary to hire a company to perform those duties. However, this is neither as easy nor as simple as it might seem. While in its history Petrobras has developed its own internal maintenance, there are factors that have forced it to change. Factors in the international and national market have made Petrobras need the help of Maintenance Service companies that can provide a better service than it can provide for itself, with better completion times and lower overall costs. This change in philosophy is not only motivated by a search for efficiency, but also because the Global Petroleum job market is suffering from scarcity, producing higher salaries and competition for recruits. Oil companies in a region like South America are not only competing with countries in that region for top talent, they are now competing with oil companies all over world. Salaries are rising as quickly, and a qualified employee can pick and choose from multiple competing options. This is leaving Petrobras vulnerable and in need of help. Brazil’s oil reserves are growing exponentially, and so are their investments in assets: Despite its size, the Tupi field poses significant engineering hurdles that will drive increased costs in tapping the field. Petrobras currently pumps 1.8 million barrels daily from its Brazilian fields and expects to boost its $112 billion in planned spending over the next five years to assume the Tupi project. […] In one rough estimate, Petrobras' Repsold says the company might need to drill 100 wells to develop Tupi. Shaw believes that means Tupi may cost between $50 billion and $100 billion to develop. A first well at Tupi cost $240 million and required two years to drill.15
This type of investment would require roughly between 1 to 5%16 in maintenance. The major difficulty for a company with growth perspectives that are this abrupt is finding qualified human resources to manage those investments. This is not only a problem for Petrobras. Once oil prices raised over U$50 a barrel many more companies entered into exploration & production, creating a much higher demand for qualified human resources. For Petrobras this may be even more intense, because of the type of deep‐sea sub‐salt drilling that they specialize, which is the most expensive with the highest risk. With employment agencies offering job placement around the world through the Internet, the competition became truly global. A company in the United States or Europe is now competing with companies in Russia or Australia for top talent:
These difficulties will continue until more qualified laborers enter the market, and this excess in the demand will last for at least five more years18. The situation is further complicated by Brazil’s labor laws which estipulate that two thirds of the labor force and labor salary is assigned to Brazilian citizens. Several factors make the skills ‘reservoir’ of the Oil & Gas industry a real issue: • High average age of the present professionals • Reduced amount of engineers at western universities • Increase in energy demands • Increase in technology The first two are typical for the baby boomers generation and other industries have similar problems. However due to the restructuring and lay‐off rounds of the last 15 years in Oil & Gas the industry has them worse. The last two are due to the fact that the size of the world population is growing rapidly, the standard of living is increasing and it is becoming more difficult to increase the world’s oil and gas supply. At the same time the world has become more dependent on oil and gas and less on coal and nuclear energy. The gains in efficiency will not compensate the gap caused by the baby boomers leaving. The increase in demand and technology will mean that the industry has a continued need for skilled people.
If you look at recruitment and human capital management for a global industry than it has many challenges. Differences in culture, education levels, pay scales, laws, pensions, etc.. The challenge for companies is how to recruit on a global basis and how to make sure that the employees will develop and stay. For that reason very few companies have recruited on a global basis, most have recruited in their country of origin which for a large part of the industry is the US or Europe. In the next 10 years a major shift to more international recruitment is needed to meet the gap that will occur with the baby‐boomers leaving, the reduced output at the western universities and competition of other industries. This limitation will affect Petrobras, as much as an international Maintenance Service Company trying to develop their maintenance team.
To be able to combat this difficulty, a company like Petrobras would have only a few options: invest more in developing their own in‐house team or outsource this service. Currently, in one of the larger Global Oil and Gas Recruiting Websites Worldwideworkers, their database contains over 230,000 contacts, of which 8%, 18,690 are from South America or speak Spanish. Considering the market’s growth in Brazil, as well as other countries in the region, it will be very difficult to comply with the law and have high qualified labor. Projects will be continually delivered later, and maintenance work stoppages will be the norm:
This delay resulted in a reduction of 22% in production over last year (2008 vs 2007). With these difficulties, Petrobras will need help for the next few years, if not decades, as it continues to find new oil fields, but is unable to provide for its own service and maintenance needs.
Degrees of differentiation
Given the high demand for Service Companies, strategic differentiation is not needed for the success of a company in this Industry (till 2014). However, it is applied because of the limited resources of any given company. There is a high degree of differentiation in smaller companies, like Alphatec, that cannot bid by themselves, or can only bid in a certain type of work. This type of company will focus not only on one of the areas, i.e., Upstream, Midstream or Downstream, but in one type of labor in that area, i.e., Pipe maintenance in Upstream. This is further reduced by region, i.e., Pipe Maintenance in Upstream in Macaé. When a company is larger, with greater resources, it can add virtually any link in the Value Chain to its products and services. There is enough offer of contracts that a large company does not need to specialize, it can in fact benefit from having a wide variety of skills, as it can participate and win in more bids. Again, the only limit being the resources of the individual company, or the access to subcontract resources.
4.2. Entry of new competitors
A market that yields high profit margins attracts the attention of new competitors. This increase in competition will effectively decrease profitability. Established competitors can, through strategic measures, create barriers against the entry of these possible new competitors, and protect their industry from more competition. In the case of the Brazilian Oil and Gas Service and Maintenance Industry, there is great expectation for growth. The market’s main client, Petrobras, is the partially government‐owned oil company of a country that has recently confirmed its oil reserves to be around 18.7 billion barrels, making it the 12th largest reserves in the world, with still more oil fields expected to be discovered. Petrobras’ goal is to produce 3 million barrels of oil a day, and make Brazil a major global oil player20.
This future will demand the investment of billions of dollars worth of new assets in Platforms, Refineries, FPSO’s, all of which will require Service and Maintenance. Maintenance costs represent 1%‐5% of Capital Investment on a project, will definitely make the Maintenance Service Industry in Brazil an attractive industry for international competitors. However, it will not be easy for new competitors.
For a foreign company to enter the market with a Greenfield strategy, there are two major sources for barriers: The Brazilian Government and Petrobras, in particular its CRCC requirements. In general, Brazil does not restrict foreign ownership of domestic enterprises; nonetheless, its Corporate Law does open doors for foreign investments. Originally Brazil, like most South American countries, had closed borders to foreign investment. The main industries were regulated and run by government‐ owned companies. In 1995, the world’s largest privatization plan opened up most of those industries in Brazil. As a result, prior permission is not required to establish a business in Brazil. Opening a new corporation in Brazil takes 18 different procedures that last 152 days on average. Addendum 2 identifies each procedure, along with the organizations where the procedure has to be completed, and the length of time it can take to complete each procedure. In the Doing Business Report 2008, which includes 182 different countries, Brazil ranked 122 in ease of opening a new company.
Establishing a new corporation is one of the most difficult and time consuming barriers for new competitors. Another government issue would be environmental licensing21. There is no predictability in two aspects: when the environmental license will be issued, and what the cost of environmental compensation will be. As well, Brazil is one of the few countries in the world that taxes investment. This is a distortion that increases costs for those who decide to invest funds in the Country. With higher charges in one place and several options for investment, many companies decide to allocate investment where charges are lower, generating jobs and development in these areas. More detailed information about the rules and regulations of starting up a legal entity can be found in addendum 3. Petrobras CRCC22 Petrobras’ control on the market, its concentration of power, is best illustrated by two examples: • The requirements it places for its authorized product or service providers; • The number of companies it has bankrupted as a result of its requirements in its contracts.
The main focus of this chapter deals with the first of those two. The CRCC is what Petrobras has named its process of making sure that a company will be Technically, Managerially, Economically, and legally suitable and able to complete its contract. This process also includes the SMS, which evaluates the company’s environmental, health, and labor situation. The authorization is provided not only for a company, but for an individual “item”, be it a service or a product. This authorization needs to be renewed each year, for the company and each individual item that is authorized.
2. Technical capacity is appraised by examining the following documentation, to which, for purposes of classification, are divided into three Degrees: b.1) List of works or services performed by the company, indicating the kind, characteristic, name of owner, value, duration of execution, start and completion and name of the inspection agency, if any; b.2) A statement that, under the company's responsibility, or as an effective representative of a joint venture, it has satisfactorily performed services of its specialization listed in item b.1 herein above, or a statement of technological transfer that makes it appropriate to perform a certain work or service; b.2.1) The performance shown by the company in providing a service to Petrobras will also be considered;
b.3) List of equipment of its ownership or whose use has been guaranteed by agreement, grouping them by similar areas whenever considered necessary;
b.4) Curriculum Vitae of the director(s) and/or manager(s) and skilled personnel of a university and/or intermediary level. c) The economic‐financial status is obtained by weighing the following indicators, obtained from the balance sheet and financial statements of the last company year: 3. The Economic‐financial status is evaluated on the company’s Profitability, Liquidity, Capitalization and Fixed Assets. All three of these aspects of the company are quantified 24 and then a Ranking of A, B, or C is provided. The company's registration, however, will not prevent Petrobras from reviewing its registration and classification at every and any moment, and it may be canceled, suspended and even excluded if it sees fit. Petrobras may visit a site and solicit information concerning any object that it finds on the premises. Such attention to detail can delay the progress of any project, especially if the company is not well prepared for such visits. Failure to comply with these requirements can result in fines, or even the termination of a contract.
The contracts diversify risks, even for the largest companies. Recently Halliburton, a former client of IESA, had to cancel a US $1 billion platform contract, because of general difficulties, and had to pay Petrobras close to US $600 million. Projects of this size, while extremely lucrative, are incredibly risky.
All of these requirements for foreign investors and procedures for its vendors create barriers for new competitors, to such an extent that most international companies are better off purchasing a local company than risking certain difficulties. More information about Petrobras certification process can be found in addendum 5.
Switching costs
Petrobras Maintenance Contracts for Platforms have a five year lifespan. These bids have many restrictions in place to protect Petrobras and the Bid Winner. They are not easy to dissolve, and there are many difficulties, financial and otherwise, that make switching a provider greatly unwanted. In fact, the lifespan of these contracts was extended by Petrobras from a one year standard to five years to help stimulate competitors, as the longer contracts are more attractive for companies; Petrobras is also able to demand higher standards of quality. As such, rivalry is reduced by Petrobras’ high switching costs and the longer contract lifespan. There are only a number of contracts that one company can handle adequately, and if a new contract bid opens, a company with many contracts will have to refuse participating. This is relatively common, for example Skanska had to do it a number of times to maintain the level of quality required in their other contracts.25
24 Addendum: 5
