Key points

Five years of US Internet development took just one year in Latin America
B2C may stand a better chance in Latin America than in the US .
. because wealth is concentrated and category killers have yet to emerge
B2B initiatives in Latin America promise substantial cost savings .
. but oligopolistic structures mean that B2B will look different than in the US

By Karchi Lukac, Daniel Baranowski and Jim Kunihiro*

Internet start-ups have attracted most of the publicity in Latin America's nascent Internet economy. But new research suggests that bricks-and-mortar operations, with their greater business experience and fulfilment expertise, will win the day. This analysis was contributed to the EIU ebusiness forum by Bain & Co.

Latin American Internet start-ups are attracting a lot of attention. In the past 18 months they have captured more than $1.84bn in private funding. But are these pure plays going to win the Internet war?

Probably not.

Many of these "flash in the pan" companies are struggling and will soon fail. Some high-fliers will simply run out of cash because of high burn-out rates and an increasingly sceptical investment community.

The pure plays are likely to yield the field to clicks-and-mortar counterparts that can leverage less glamorous—but difficult to replicate—capabilities such as fulfilment and customer management.

Over the longer term, bricks-and-mortar companies will capture the lion's share of profits from the Internet in Latin America. Many of these incumbents are moving aggressively to leverage their significant scale, assets and industry experience to develop winning clicks-and-mortar business models. To succeed in this market, companies will need to incorporate the Internet into their business processes effectively while adapting their strategies to the specific characteristics of the Latin American marketplace.

Without local savvy, mere imitators of US e-business models are doomed to failure.

It's not just the US all over again
Over the past year the Latin American Internet market's evolution has mirrored that of the US, only at a highly accelerated pace (see Exhibit 1).

What happened in the US between 1995 and 2000 has taken place in less than a year in Latin America. The first Internet start-ups basically mimicked US models. These aimed to import or 'tropicalise' successful US business models such as portals, online retailing and auctions. US-trained Latin Americans seeking to create the next Amazon (Submarino), Yahoo! (StarMedia, El Sitio) or eBay (Mercadolibre, Deremate) were typically the driving force behind these ventures.

Although these companies were once the darlings of the investment community, many are now struggling to satisfy the demands of the post-Nasdaq-crash "new new" investor. In fact, the stocks of three prominent public Latin American Internet companies have fallen by an average of 71% from their peak in February; many Latin American Internet IPOs have been postponed. Clearly the answer is not always to copy blindly what has happened north of the Rio Grande. This is not to say that there are no lessons to be learned from the American experience. In fact, many of the same factors that have powered clicks-and-mortar successes in the US will also drive success stories in the Latin American market.

Latin American companies that seem to get it
Internet ventures can reward old-economy companies with greater profitability and perhaps valuable equity stakes in separate Internet entities. Lucrative Internet investment opportunities are not limited to day traders and institutional investors. Cemex, a Mexican cement company, hopes to profit from the Internet through its $50m investment in e-business accelerator Puntocom Holdings, which will roll out B2B Internet ventures across the region. Puntocom has already invested more than $10m in B2B ventures, according to the CEO, Raul Rivera. The real value creation, however, emerges when a company not only invests financially in Internet opportunities but is also positioned to realise synergies between its core business and its Internet franchise.

Several Latin American companies are already seeing their initiatives pay off as investors reward them with higher valuations. Pão de Açucar, a Brazilian grocer and an Internet pioneer, has seen its stock shoot up by more than 200% over the past year. Although online sales represent a mere 1% of total sales, analysts have actually valued the company's Internet division, Amelia.com, at 25% the value of the entire bricks-and-mortar operation! Another example of investor confidence in the clicks-and-mortar realm came in December 1999 when Mexican banking concern Banamex announced a B2B joint venture with CommerceOne. The result: a continuous rise in the value of the stock. In December alone it increased by 20%. By March it was up nearly 80% and reached an all-time high, before falling back to earth in conjunction with the Nasdaq. Even though the venture's name of Artikos was just announced, analysts have already valued it at 20% the value of the bricks-and-mortar assets. By focusing their assets and market power on e-procurement and B2B portals, traditional bricks-and-mortar companies can streamline their supply chain and improve internal processes to achieve record profits.

B2C in the Latin American context
So far, B2C ventures have garnered the most attention in the press and from investors, obtaining more than $253m in funding in 1999 and 2000. Latin American B2C sales are projected to reach $8bn by 2005. This may seem slight compared with the US figure of $177bn, but what is intriguing is that demographic differences in Latin America could make several B2C business models that have struggled in the US viable in Latin America. First, consider that wealth in Latin America is highly concentrated in certain individuals and geographic areas. The top 20% of the population controls 60% of the buying power, which translates into an average income of more than three times the regional average. Second, in most Latin American cities the upper class is very geographically concentrated, residing in only three or four neighbourhoods. This has a profound impact on what business models will flourish in the region. For example, this smaller requisite coverage area for target customers results in the feasibility of business models such as home-delivery groceries—while Webvan has struggled in the US, home-delivered groceries are already profitable in Brazil.

Another difference between the US and Latin American markets concerns the evolution of the retail sector. In the US "category killers" such as Toys R Us and Home Depot emerged in the late 1970s and 1980s and attacked traditional full-line department stores. These category killers came under attack themselves by vertical Internet start-ups such as eToys and Amazon. However, because of regional economic and demographic factors, category killers never emerged in Latin America. Thus vertical B2C Internet players are seen as a direct threat to full-line department stores such as Palacio de Hierro in Mexico and Lojas Americanas in Brazil.

The opportunities and challenges of B2B in Latin America
While bricks-and-mortar companies are clearly in an excellent position to leverage the Internet as an alternative distribution channel, the real opportunities lie in B2B e-commerce. Although the value of the Latin American B2B market is projected to be between $124bn and $175bn by 2004, the real question is how much of this will be conducted over exchanges and auctions (e-marketplaces) and how much will be traded directly between companies. The answer is that the vast majority of the trade will probably take place bilaterally through vertical portals established by bricks-and-mortar companies. Independent B2B start-ups such as Asista, Agrozona and Aceronet had received only $45m of venture capital and will struggle to succeed if they cannot quickly achieve scale. Indeed, in Latin America bricks-and-mortar companies will dominate the B2B scene in many industries because of their inherent market power and their desire to cut costs and to capture the equity upside of their Internet ventures.

Overall B2B e-commerce is expected to have a significant impact in Latin America, as suppliers tend to be extremely fragmented and inefficient. Both suppliers and buyers have been very slow adopters of technology such as electronic data interchange (EDI) because of its high set-up and operating costs, estimated at $150 per hour. In many Latin American industries the implementation of enterprise resource planning (ERP) software and EDI adoption lags five to ten years behind the US and Europe. The Internet provides an ideal means to leap-frog technologies in its ability to transact and streamline activities across a company's entire value chain. In fact, Bain research shows that in the Latin American retail sector, B2B initiatives could have significant bottom-line results. Savings from lower purchasing prices, lower transaction costs and less inventory could decrease total costs by 12% and result in up to a 40% increase in operating margins.

However, B2B in Latin America will not evolve as it has in the US because of structural market differences between the regions. Many industries in the region are dominated by a few huge players. This makes it particularly difficult for independent exchanges to penetrate and compete in these oligopolistic industries. In addition, consortia exchanges, which are the trend in the US, will not be as popular in Latin America because of the hesitation of dominant businesses to enter into ventures in which they do not have majority control. Many of these companies are family owned and are not accustomed to joint ventures or deals in which they do not have at least a 51% controlling interest. The result could be that many Latin American bricks-and-mortar companies might set up their own closed B2B portals for procurement and supply-chain management.

Key success factors in Latin America
In order to succeed in the Internet world, we recommend that Latin American executives and bricks-and-mortar companies focus on the following key areas:

Value-chain specificities. Look across your company's and industry's entire value chain and see which components are most threatened by the Internet and which areas offer the greatest online opportunities. Find where the most leverage is and don't be afraid to redesign entire business processes. Failing to do so means running the risk of falling behind more astute competitors that take difficult yet necessary steps to increase profits and market valuations.
Strengths and weaknesses. Each organisation must carefully assess what its core capabilities and shortcomings are and then think of how these skills may translate into Internet success. Companies must aggressively address their shortcomings through outside help or partnerships.
Technological investments. Invest in technology and in the technological know-how of your own company. Make sure your managers have computers, receive training and have incentives to use the Internet. A clever Internet strategy does nothing for a company whose employees don't have computers. Consider audacious moves and don't underestimate the time and money required to bring your own organisation up to Internet speed.
People. Possibly the largest obstacle for Internet initiatives by bricks-and-mortar companies, particularly in Latin America, is a shortage of talent. Hiring a group of computer scientists and programmers is not enough; what is crucial is to maintain an eclectic mix of seasoned industry professionals and technology-savvy newcomers. Be prepared to compensate these people adequately for their skills and give them the right incentives. If you don't, someone else in the market will.
Speed cannot be stressed enough. The importance of quickly mobilising and implementing Internet strategies is critical. There is currently a land-grab going on in the building of vertical portals and in the B2B space. As B2C and B2B sites proliferate in Latin America, winning business models must continually adjust to changing market conditions and must add value to all participants.

*Karchi Lukac is a director at Bain & Co and the head of the Mexico City office. Daniel Baranowski is an associate consultant and Jim Kunihiro is a manager at Bain & Co, Boston.

Source: Submitted to the EIU ebusiness forum by Bain & Co.