Latin America presents a plethora of opportunities for Multinationals, from market development on a region with an aggregate GDP in excess of five trillion USD, to manufacturing, to supply chain management, to back office operations in a lower cost environment; but it is not free of challenges. It is one of the most complex regions in the world to do business in. Take taxes for example. According to a recent survey by Doing Business from the World Bank, it takes on average 478 hours a year to prepare tax returns in Latin America versus 177 in the high income countries and 186 in the U.S.
The region is not homogeneous either. Mexico and Central America are strong exporters of manufacturing goods to the U.S. and thus tied to its economy. South American economies are often exporters of energy and commodities, with a presence in the Chinese market. Individual countries vary significantly from culture to statutory requirements to infrastructure. Doing Business points out that, on average, it takes 116 hours to complete export border compliance steps the region, versus 15 for the OECD countries. But this figure can be as high as 815 hours in Venezuela or as low as 20 in Costa Rica.
This regional intricacy can permeate operational decisions resulting in progressively complex business operating models that obscure visibility and make controlling indirect costs challenging. Without managing this complexity, cost to serve is poorly understood, working capital management is neglected and opportunities to optimize back office operations and leveraging technology are seldom realized.
1. Managing Complexity
Operating model complexity—if not expressly managed—tends to grow as organization structures, business processes, decision making authority and information technology solutions are added to address pointed issues or capture emerging opportunities.
A common case is the distribution footprint. Volumes in Latin America are typically smaller and more variable than in developed markets, making it difficult to achieve economies of scale. Localization is advantageous due to country specific preferences, but comes at the cost of inefficiency. The scale of the region, along with a lower urban concentration is a challenge on its own. The top ten cities in Latin America are―on average―2,300 miles apart, almost three times (2.7) the average in Europe. Adding to this, variable exchange rates can rapidly shift competitive advantage from one country to another.
To be successful in such a complex environment, you need a Latin American specific distribution strategy that takes into account the idiosyncrasies of the region and turns challenges into advantages. International duties, free trade zones and other local trade characteristics need to be embedded in designing the supply chain. A machinery company shifted production of a core component from Brazil to Mexico, where manufacturing and distribution cost was higher, but it was more than offset by savings on duties provided by NAFTA. To balance scale and localization, many large companies build their distribution networks around regional clusters to balance scale and localization.
Being able to analyze and quantify the costs associated to each activity involved in fulfilling demand—including procurement, manufacturing, distribution, logistics and sales—at a product and customer level is key to understand and improve profitability.
A good cost to serve model is critical to optimize the supply chain network and it provides a strategic advantage when negotiating with existing and prospective customers. In addition, it informs marketing and finance, improving expansion (or right sizing) strategy and capital investment decisions. Access to consistent data across the supply chain is a pervasive challenge in general, but in Latin America this complication can exacerbated by currency fluctuations and local nuances.
One implication is that the cost to serve model needs to be dynamic and able to rapidly adapt to a changing environment and provide insights as they occur. Building the right cost-to-serve capability is a tall order, but once in place, it can become a significant competitive advantage.
While everyone recognizes the importance of working capital, its components are often managed in isolation. Inventory by operations, receivables and payables by their respective financial corners; leaving sales only marginally involved or accountable for policy compliance. An integrated working capital management (WCM) policy should balance trade-offs among its main components—payables, receivables and inventory—and be explicitly tied to sales projections.
A long cash conversion cycle—the length of time, in days, that it takes a company to convert resource inputs into cash flow—tends to be inversely proportional to profitability, as it promotes overinvestment in working capital. A goal of WCM should be to minimize the cash conversion cycle without negatively affecting operations.
Companies operating in Latin America tend to overly extend the cash conversion cycle due to a number of factors, including deficient collection policies, poor sales projections and complexities associated with inventory management. In some cases, the payables cycle is shortened because of the perception that local vendors won’t be able to survive a more stringent policy. In a recent analysis, a company paid suppliers in 15 days or less using the survival argument. Further analysis of the supply market, demonstrated that comparable suppliers were being paid, on average, in 40 days by the rest of the industry.
The heterogeneity of the region adds complexity to inventory planning and often results in lack of accountability, low policy compliance and poor decision making. Enhancing visibility across the supply chain and establishing the right accountabilities, inventory policies and priorities is key to maintain service levels while keeping inventory levels from skyrocketing.
4. Optimizing Back Office Operations
According to a recent Auxis survey, less than half of the Multinationals with operations in the U.S. have Shared Services Centers (SSC) in Latin America performing back office operations for North America. Meaning that they are either leaving an important labor arbitrage opportunity on the table or that they are utilizing an off-shore model (e.g. India or Philippines).
Nearshoring provides a sensible alterative for both. Cultural similarity, overlapping time zones and accessibility make for a good business case and promote higher involvement from leadership. A flight from Miami to Costa Rica takes less than three hours. Outsourcing is another alternative to rip the benefits of labor rate differentials without the burden of setting up an operation from scratch and taking advantage of the outsourcing partner’s experience with the region. Hybrid models are becoming more common, giving companies the flexibility to develop certain services in house while outsourcing mature or purely transactional operations.
While a key component of an indirect cost reduction strategy, labor arbitrage is not its only element. Continuous process improvement and task automation play a significant role in providing high quality—and compliant—services at a low cost, and by being part of a particular operation, enable differentiation. Unfortunately, this is often neglected. Many SSCs are established on the basis of labor arbitrage with plans to improve processes in a future date that never seems to come. The opportunity cost of a stagnant center is larger than the immediate savings generated from increasing the efficiency of the current service portfolio. It also neglects the adoption of additional—more profitable—services that are not implemented due to compliance risk or simply lack of trust. Automation plays a key role in the continuous improvement process.
Beyond basic ERP capabilities, technology is largely underutilized by Multinationals with operations in Latin America, despite a growing business case. As discussed above, many operations, that started based on an arbitrage rationale, have neglected investment in automation technologies. The result is a labor intensive environment that is prone to error and high in compliance risk. Ironically, the centralized nature of an SSC provides a setting where compliance can be better managed. This setting, in combination with the right technology, is a powerful combination that can bring highly compliant, yet efficient processes to live.
An example of this compliance-efficiency duality is the growing availability of electronic invoicing in many Latin American countries. Mexico and Brazil are two examples where electronic invoicing is mandated by law, and strict compliance standards enforced. While these mandates owe their origin to compliance issues, the resulting standardization of the process can be turned from a burden into an opportunity to fully automate the invoicing process. A feat that has been eluding the U.S. and Europe for decades.
More standard back office technologies such as workflow and optical character recognition (OCR) are not usually fully leveraged and Robotic Process Automation (RPA) is yet to be seriously explored in the region.
Planning—demand, supply, DRP—and Global Trade Management tools are also underutilized in the region, limiting visibility and hampering innovation. Advanced business intelligence methods, including predictive analytics, data mining and machine learning applications can be used to streamline the supply chain, form simple SKU rationalization to fraud detection to strategic market segmentation.
Turning Challenges into Advantages
Managing complexity, understanding cost to serve, improving working capital management, optimizing back office operations and leveraging technology are pressing business issues that, while not exclusive to the regions, take a specific shape in Latin America. Recognizing the challenge and taking steps to define an explicit strategy to address them can generate tremendous opportunity. In future posts we will discuss each of these issues individually.
Are you facing any of this challenges today? What actions are you taking to address them?