IKEA's Entry Into South America

Executive Summary

Ikea seeks to continue expanding its retail presence around the world through worldwide franchising of the Ikea concept. We propose an immediate expansion of Ikea into South America, specifically a storefront in Brazil. Using a balanced scorecard approach we address the primary issues in such an expansion. We also believe Brazil is a logical candidate for longer term expansion on the manufacturing (sourcing) side of Ikea and provide supporting analysis for such expansion.

Although we have limited access to actual Financials, we believe the initial investment required to be about $20 million. Sales estimates exceed $70million per year. Since costs should also be typical of other sites around the world, expected earnings after tax are 8% of sales.

In addition to the need for access to capital, a well-located site for retail activity must be secured. This site would be at the edge of Rio de Janeiro or Sao Paulo near highway access.

Marketing Strategy: “All marketing is based on the IKEA business idea: We shall offer a wide range of home furnishing items of good design and function, at prices so low, that the majority of people can afford to buy them” Although Brazilian customers are used to negotiating on price, we feel a fixed price retail store will do well since the prices are low, and the shopping experience is primarily self-service.

Most of the over 6000 products will continue to be produced in Asia and Europe. All products will continue to come through Ikea’s distribution channel. Since the majority of furniture comes in a flat package, the distribution method has been proven to be cost effective. The possible need for regional distribution center is a risk factor that would increase investment required.

The regulatory environment in Brazil allows foreign investment and the repatriation of profits. With respect to people, Ikea has a strong culture. Ikea is a value driven company that values hard work. About 400 Employees will be hired for the first Ikea Brazil store. Training is available through Ikea University, which is uses traveling instructors and on line training materials. Overall Brazil looks like an attractive entry point into the South American furniture market.

Background

Founded in the late 1940’s by Ingvar Kamprad created the concept of IKEA, a furniture company that provided quality fashionable furniture at prices everyone can afford. Although its business model at the time was much different then the mega stores today, this fundamental approach to furniture has remained the same.

Despite its very risk-adverse nature, IKEA became the first furniture company to expand internationally. High bulk to value, high transportation costs, and susceptibility to damage are all issues IKEA was able to overcome with its innovative approach of selling furniture collapsed flat boxes. This approach not only lowered its shipping and inventory costs, but also creatively transferred the labor-intensive assembly costs to the customer. IKEA’s innovate approach to adding the consumer to the value chain in effort to keep prices low and quality high has won it very loyal fans everywhere it has reached.

Packed to the brim, its stores attract customers from great distances who load up their cars to furnish entire rooms or homes in a single trip. Constantly introducing new innovative new products, its model rooms in its stores and catalogs have provided a creative way introduce its new products to complement its existing product line. The model rooms and catalogs teach the customers how to piece together an entire room from the furniture to the décor with all IKEA products. Fashionable and trendy it encourages customers to live the IKEA life.

Financials

Background: Ikea is a privately owned company with an extraordinarily opaque organization. Financial statements are not publicly available. The Ikea Group is ultimately owned by the Stitching Ingka Foundation, a charitable trust based in the Netherlands. The Ikea Group manufactures and sells products. Franchise stores are a part of the IKEA group, as shown in figure 1. However, Inter Ikea Systems, a separate company, owns Ikea’s intellectual property.

Franchises: “Inter IKEA Systems B.V. constantly seeks market expansion, and grants new franchises to markets/territories according to a detailed expansion plan” (Company Web Site). Ikea has identified location as a primary success factor, since store sales volume is so dependent on location. Franchises are granted only to organizations and/or individuals that can secure a strong market position and market penetration in the given territory [and have] the financial strength and potential as well as have identified well located sites for the retail activity.”

Investment required: Based on recent examples, such as the Ikea store opened in Israel in 2003, typical investment is ~ $15M with a leased store.

It is estimated that another $5M would be required for the building and infrastructure improvements. It is also estimated that a new distribution center may be required for the region. If this is required, it is likely multiple stores will be needed to justify such an investment.

Revenue: With 190 stores, sales top 12.2B Euro. This means on average each store generates 67M euro ($78M/store). To validate this assumption, it should be noted that Germany accounts for 1/5th of turnover with a proportionate 33 stores.

Costs: The Ikea store concept requires relatively little human resources, so costs are a function of other overhead such as lease, warehousing, utilities, taxes and advertising. It can be noted that manufacturing is primarily Poland and Asia, as Ikea grows in size, it should consider Brazil as third major manufacturing center for local and worldwide use.

Earnings: After tax earnings for the IKEA group were shared in the 1997 book, “The History of Ikea.” Figures in the book show Ikea posted a profit of $905 million or 8% of sales. Other sources have estimated after tax profits as high as 18%. This indicates the stores are equally profitable, but must be verified before moving forward. Profits and royalties can be repatriated from Brazil.

While not all of IKEA stores were profitable, most were. In order to go forward with this project we would want to verify the success factors and make sure our pro-forma financial statements were similar to other successful stores.

Planned Store information

Size 24,000 to 32,000 square meters

Products 6,000 to 10,000

Room Settings 45 to 50

Parking Spaces 800 to 2000

Customer Loading Spaces 20 to 50

Cash Lanes 16 to 30

Restaurant Seating 400 to 700

Co-Workers 380 to 500

Land 24 to 30 Acres

Production

Brazil has abundance of high quality wood and low labor prices. This is an important reason for IKEA-Brazil to produce the furniture in Brazil and distribute locally.

Brazilian taste for furniture indicates that they appreciate wider moldings that the standard American moldings. This along with a few more customizations might be essential to market IKEA products in the Brazilian market.

In the late 90’s there has been an increase in quantity (+2.5%) and a simultaneous increase in exports (+11%), which show the increasing competitiveness of the Brazilian industry on international markets. Factors at the root of this process are most certainly the use of ever more advanced technology acquired thanks to huge investments in capital goods (in 1996 US$ 220 million was invested in machinery, mainly from Italy, Germany and the United States) which has increased the productive capacity of sector companies, and the effects of the process of opening up to international trade which intensify the significant comparative advantages of Brazil compared to other exporting countries: excellent quality raw materials at low costs and flexible labor.

Delivery

Latin America’s most important trade show happens at Brazil and this is the most sought after trade show. Brazil stands as the main sourcing country for furniture for the whole of Latin America. Brazil is the largest country in South America and shares its border with a lot of countries. Since the South-east of Brazil is the economic center of Brazil, cities Rio de Janeiro and São Paulo are favorable places to establish IKEA stores. Land transportation is becoming more effective in that about 85% of Brazil’s people and products are transported by road. Brazilian highways are of modern design and link all the state capitals by paved roads. Problems still arise in the rural and remote areas as water floods the roads making them impassable for days. Sometimes road construction after the floods is delayed inhibiting travel even more.

IKEA-Brazil can offer high quality products at low prices with the efficient methods of distribution and close relationships with manufacturers. This will ensure that even during problematic situations like flooding, the majority of the sales are not affected due to transportation issues. The same principle used everywhere else where the need for distribution is cut out by offering flat-packaged items that are warehoused in the stores and picked up by the customers on site, will be the key. The customer is spared shipping, storage and assembly costs resulting in dramatically lower product prices.

Issues with the labor workforce

Labor is cheap in Brazil compared to Europe and America. But with this cheap workforce and swinging economy of the country comes a multitude of issues that are worth investigating. Half of the labor force in Brazil is employed in the informal sector. Even though the government employs minimum wage, this is hardly followed and the wages are compensated often with respect to the fluctuations in the economy. In Brazil, 50 percent of the workforce is outside formal collective bargaining structures. Thus the labor laws in Brazil might make it expensive to employ workforce.

Quality Goals

International companies are already sourcing out of Brazil for the past many years. Crossmart Brazil has nearly three decades of experience sourcing product for European catalogs out of 40 Brazilian plants. Crossmart relies on seven inspectors who constantly visit plants to check moisture content, finishes and overall quality. It is estimated that the company currently does $20 million a year in French mail orders alone. In the southeastern production centers of Brazil, we find products with a good qualitative level thanks to the use of modern production processes and suitable machinery. The effects of technological innovation and design created by some important trade fairs in these regions are also worth mentioning.

With this kind of a history, the IKEA plant in Brazil should be able to achieve the quality standards that they have been able to measure up to internationally. Their products are not over-engineered to give a greater finish than the customer requires. Nevertheless quality is taken very seriously and the whole supply chain participates. The Ikea definition of quality is that the product must first be available in the store and secondly it must match up to the customer’s expectations: it must be complete, free from defects and easy to assemble. Returns to stores are analyzed and each product is carefully monitored.

Legal and Regulatory

It is important to note that Brazil is very friendly to foreign investors – domestic investors and foreign investors are treated equally. The largest restriction is that you must obtain a permanent visa in order to invest in Brazil as a foreigner – however, earnings may be repatriated after waiting for foreign currency to become available. The Ministry of Labor must approve this visa application. The minimum investment required is $200,000 (US) or the equivalent. The National Immigration Council can make exceptions if the new venture will create at least ten new jobs, or is of social interest. Once the visa is granted it will be valid for two years. At the conclusion of the initial two-year period the Ministry of Labor will perform an evaluation of the business to determine the feasibility of the venture before granting a definite extension.

Internal Standards

Foreign investors are encouraged to initiate discussions with state development agencies within the country. These agencies are available for government incentive programs. In addition to contacting local agencies it is important to note that a wide range of credit and financing options are available to investors through both foreign and domestic banks operating in Brazil. Finally, foreign investors are expected to import the funds for all major fixed capital requirements.

Cultural and Environmental Conditions

Personal contact is more important in business than other forms of communications (i.e. telephone or mail). This is largely because the working relationships in Brazil are built on trust.

The most common form of doing business in Brazil is through incorporated subsidiaries; branches are very difficult to operate. Joint ventures do not require a local Brazilian partner, however, it is still encouraged.

It is essential to establish a network of connections with the public sector in Brazil. The culture in Brazil relies heavily on favors and ‘who you know’. These connections are important, but it is important to remember that these connections can, and will, change.

Lastly, be prepared to negotiate on prices! Do not expect sales to occur quickly, and keep your best price till last.

People

IKEA has a company philosophy to create a better life for its customers, as well as its co-workers. This has significantly influenced the company’s workplace environment. IKEA received the Family Champion award and is recognized as a great place to work here in America. IKEA empowers their coworkers and respects their personal lives. This has had a tremendous influence on job productivity, growth and development, which ultimately benefits the customer. The IKEA workplace includes many benefits and family friendly initiatives to support co-workers needs. In 2002, IKEA saw a 26% decrease in sales staff turnover. In addition, women represent more than 48% in management positions and are 47% of the company’s top earners.

This provides a proper fit for both IKEA and the Brazilian workforce. Brazil is a nation in which the richest 20 percent of the people receive 64 percent of the national income. It is a nation in which 40 percent of the people live on the equivalent of $2 US a day and over 20 percent live on the equivalent of $1 US a day. In May 2003 unemployment was up to 12.8%-it highest level in 14 months. For those that did work, the average wages in May 2003 fell to $290 US, 15% lower than a year earlier. However, the Brazilian workforce is renewing. The job market is very attractive to the ages of 25 to 39 years old. Brazilian women are making up a larger portion of the workforce. In 1970, only 18.5 percent of Brazilian women worked outside the home. This has since rose to 51 percent of the Brazilian workforce. The number of High School graduates has also risen from 35 percent in 1994 to 43 percent currently.

A.T. Kearney’s 2004 Top 12 Ranking for Offshore Location attractiveness includes Brazil:

1. India
2. China
3. Malaysia
4. Czech Republic
5. Singapore
6. Philippines
7. Brazil
8. Canada
9. Chile
10. Poland
11. Hungary
12. New Zealand

The A.T. Kearney Offshore Location Attractiveness Index analyzed the top 25 off-shoring destinations against 39 measurements in three major categories: cost, people skills and availability, and business environment. The study team assigned weights reflecting the drivers of off-shoring decisions based on A.T. Kearney research and engagement experience. Because cost advantages have been the primary impetus behind off shoring, financial factors constitute 40 percent of the total index weight. People skills and availability and business environment each received a 30 percent weighting. Cost advantages and a large workforce Brazil’s strong points.

IKEA has responded to national needs and cultural sensitivity issues. This has been a challenge for IKEA, but IKEA is meeting these challenges by finding a balance between country level autonomy and centralized intervention. To maintain service, quality and logistic standards, franchisees are audited for performance. The headquarters provides extensive training and operational support to the workers of all kind. The new organization has become flatter and is delegating more responsibility to subsidiaries. In addition, IKEA is committed to social policies to both employees and customers. IWAY provisions include health and safety standards, employee conditions such as access to rest areas and toilets, working hours and a minimum wage. IWAY is enforced worldwide but the criterion varies according to local culture and employment legislation. This is an additional benefit for the Brazilian workforce, where there has been some disparity in working conditions for minorities and women.

IKEA has developed a mentoring program for learning and personal development of both the mentee and mentor with the expectation that by helping people to be partners they will become better employees. The evolution for the program is for IKEA’s mentees to become IKEA’s future mentors and Partners for Growth to become self-sustaining and seamless with the culture.

IKEA’s program is innovative, not only because it is grounded in the values of IKEA’s culture, but also because it focuses on personal learning and development. It will help to secure its future as they expand, by creating a diverse group of leaders. Partners for Growth is now entering its second phase and is creating a culture where mentoring is available to all managers at IKEA. IKEA has launched Partners for Growth throughout the organization. Partners for Growth facilitates individual learning, promotes personal and professional growth and development, and has four strategic goals:

• Develop Leaders from top to bottom
• Support career development across the board
• Develop and support diversity through IKEA organization
• Strengthen IKEA culture

References:

• Welcome to the Smart State, Queensland Australia http://www.sd.qld.gov.au
• Welcome to the Brazilian-American Chamber of Commerce http://www.brazilchamber.org
• Foreign Investments in Brazil http://www.cni.org.br/produtos/com_ext/src/doing05.pdf
• Isreal Investment News, Third Quarter 2001 http://www.moit.gov.il/root/Hidden/ipc/InvestNews17.htm
• The Diamondback Online, June 26, 2003 http://www.inform.umd.edu/News/Diamondback/archives/2003/06/26/news6.html
• Human Environment and Design, International Retailing http://www.hed.msu.edu/internationalretailing/company/IKEA/
• Improving Supply Chain Management in the UK Furniture Industry, Case Study – Ikea Trading Area Poland http://www.pyetait.com/furniture-supplychain/docs/Case-Study-IKEA.doc
• Ikea’s our vision http://www.ikea.com/content/about/vision/
• Burt, Tim (1998). “Ikea rated among Sweden’s top three businesses,” Financial Times (London), Front Page- Companies & Markets, pp. 23.
• The miracle of Amulet, Guardian Unlimited http://www.guardian.co.uk/g2/story/0,3604,1240462,00.html
• Brazil and Its History http://mdmd.essortment.com/brazilhistory_rmfq.htm
• Furniture Today, Brazil showing Good growth, March 22, 2004 http://www.furnituretoday.com/article/CA419023.html?display=Special+Report “Mentoring Relationships: Using Partner Preparation tools.” Mentor, Vol. 6, No 4.