Consumer Insight Brazil Pet Products Industry by Sutherland Global Services

Consumer Insight – Brazil Pet Products Industry [April 20, 2011]

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Retail Consumer Behaviour in Brazil

Increasing urbanization coupled with favorable age demographics bodes well for the Brazilian economy Urbanisation (% of Total Population) 120

Rural

Key Observations

Urban

• 83.5% of the population in Brazil lives in urban areas

• Since the 1960s, the population living in urban areas has almost doubled

100

31.3

36.2

44.7

55.9

60 40

68.7

63.8

55.3

44.1

67.6

32.4

75.6

81.3

83.5

24.4

18.7

16.5

1990

2000

2007

• Nearly 46% of the total population live in cities with less than 100,000 inhabitants and 20.6% live in cities with a population above 1 million. The most populated city is São Paulo, with 10.9 million inhabitants

0 1940

1950

1960

1970

1980

Population by Age (2010 in Mn)

Key Observations

183.4

193.3

200.0

202.1

• Brazil is the fifth most populous country in the world

6.20%

6.90%

8.00%

9.60%

• The Brazilian population is expected to age significantly from 6.2% in 2005 to 9.6% in 2050 due to lower birth rates and higher life expectancy

63.60%

64.40%

65.30%

65.90%

18.2% 9.3%

17.7% 7.8%

16.0% 6.8%

13.8% 6.3%

• Retail companies are devising various marketing techniques and retail store formats catering to requirements of an aging population in Brazil as life expectancy increased from 69.5 years in 1998 to 72.7 years in 2008

2005

2010

2015E

2020E

0-4 Years

5-14 Years

15-59 Years

60+ Years

65+ Years

• Companies are targeting aging population by reducing store size and opening stores in neighborhood as older shoppers do not prefer to carry heavy shopping bags home

Source: Brazilian Institute of Economics Estimates, Un Population Statistics

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Brazil’s GDP growth accelerated from 2004 after inflation was brought under control and external solvency improved GDP and Growth Rate 4,000

GDP (LHS)

Grow th rate* (RHS)

0.1 0.08 0.06 0.04 0.02 0 -0.02 -0.04 -0.06

R$ Billion

3,000 2,000 1,000

19 80 19 81 19 82 19 83 19 84 19 85 19 86 19 87 19 88 19 89 19 90 19 91 19 92 19 93 19 94 19 95 19 96 19 97 19 98 19 99 20 00 20 01 20 02 20 03 20 04 20 05 20 06 20 07 20 08 20 09 20 10

Source: Brazil Central Bank Statistics

Key Observations • After the “lost decade” of 1980‟s, when an oil shock destabilized the global economy including Brazil‟s, the country witnessed skyrocketing inflation and low GDP growth • After several futile attempts, the Brazilian government managed to tame inflation with the implementation of the “Real Plan” 1994 which established „Real‟ as its new currency and rapidly reduced inflation from high 50% to less than 1%. However, the balance-of-payments crisis continued to plague the country during late 1990‟s and early 2000. • During 1999, the government adopted economic policy based on three main points: an inflation target, a floating exchange rate policy and adoption of fiscal responsibility law. Implementation of these policies helped improve the macroeconomic fundamentals in Brazil between 2003 and 2008 • Brazilian GDP growth cycle, which started in 2003, was interrupted by global crisis in 2008, however, Brazilian economy proved more resilient than in the past. With government support in the form of increased public expenditures, reduced taxation for key industrial products and increased credit supplies through public banks, GDP growth gained momentum in 2010 after a moderate decline in 2009 Source: Brazil Central Bank Statistics

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Improving income distribution has led to a burgeoning class A, B and C Consumer Disposable Income

Gini Coefficient 0.601

13.9

0.600

0.596

16.1 0.572

R$' 000

10.5

0.556

7.3 4.0

1995

5.4

0.543

1998

2001

2004

2007

2009

1995

1998

2001

2004

2007

2009

Gross Disposable Income per Capita Source: Brazil Central Bank Statistics

Source: Brazil Central Bank Statistics

Observations

Income Structure 178.7mn

29.5% 15.20%

183.4mn

23.5% 16.60%

187.6mn

191.5mn

19.2%

17.4%

14.10%

13.40%

43.2%

46.7%

51.9%

53.6%

12.0%

13.2%

14.8%

15.6%

2002 2005 Class AB (Monthly household income greater than R$4808

2007 2009 Class C (Monthly household income between R$1115 -4808

Class D (Monthly household income between R$804 - 1115

Class E (Monthly household income less than R$804

• Consumer disposable income quadrupled between 1995 and 2009 as a result of strong growth in GDP • The Gini coefficient, which measures income concentration (the higher the index, the higher the degree of income concentration), fell from 0.60 in 1995 to 0.54 in 2009 • The class C has gained share from 43.2% of the total population in 2002 to 53.6% in 2009. The combined share of classes A and B in total population rose from 12.0% to 15.6% in the period whereas the combined share of classes D and E declined from 44.7% in 2002 to 30.0% in 2009 • It is estimated that due to surge in income levels about 30 million consumers will be added in the A, B, and C income classes during the 2009-14 period

Source: Brazil Central Bank Statistics, Euromonitor Country Report

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Increasing purchasing power due to improving macroeconomic condition & strengthening middle class base fuel the Brazilian retail industry growth Retail Market Size (2005-2014): R$ Billion

CAGR:11.0% CAGR

CAGR:12.7%

189

215.9

355

388

427.4

473.3

524.6

254.4

285.8

316.6

408.8

458.5

566.6

318.2

363.2

510.9

291 2008

2009

2010E

2011E

2012E

2013E

2014E

204.5

227.8

263.8

2005

2006

2007

Food

2005-09

2010-14

13.8%

10.3%

11.7%

11.8%

Non-food

Key Observations • Brazil‟s retail market is the largest in Latin America, and is estimated to be ninth largest in the world in 2010 • Retail sales have been growing steadily since 2005 and are expected to continue to increase at this rate over the next few years as moderate inflation rate allows for continued expansion of real incomes • While traditionally small- and medium-sized companies with up to 50 employees dominated the retail segment, modern retail is fast gaining prominence with an increase in the number of hypermarkets, supermarkets and shopping centers • Overall, the market remains relatively fragmented but a process of consolidation in the retail industry is underway. Big retail chains like Brazil's Pão de Açúcar, France's Carrefour and US's Wal-Mart currently dominate the market, while smaller – typically local – chains account for little more than 1% of the national market each • Retail food sales still dominate the total retail market, accounting for more than 50% of the total retail sales Source: GPA Analyst Report Estimates, EIU Statistics

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Typical Upper Class Segment would prefer to shop in supermarkets and convenience stores vs. a discount or a cash & carry format

Store Type

SEC-A

SEC-B

SEC-C

Reason

Hypermarket

Monthly Purchase

Supermarket

Weekly Purchase

Cash & Carry

Stocking of Products

Discounters

Weekly Purchase

Convenience Stores

Convenience Shopping

Upper class Behavior (Sec A & B) • • • • •

SEC-D

Prefers exclusive products Open to experimentation, not loyal to brands Rarely asks for discounts Looks for shops with a limited assortment Expects a more formal and distant treatment by sales staff

New Middle class Behavior (Sec C & D) • • • • •

Prefers to buy „tested‟ products Always looks for a good bargain and discount Open to experimentation, not loyal to brands Prefers a wide range of products and brands Expects to be treated very informally by the sales staff

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Brazilian customers value in-store service, stores located nearby & limited product range cross premium, economy and low price segments… (1/2) • On an average, Brazil‟s mass-market consumers shops once a day. Almost 70 percent of shoppers travel by foot and hence, shopping is much easier when stores are nearby (as they need to carry their bags back)

Catchment area for retailers is limited to 2 to at- best 5 Kms

• Most Brazilians travel less than 15 minutes for their shopping trip- about one kilometer by foot or five kilometers by car • This factor has probably led to the aggressive launch of convenience format stores in catchment areas – Dia % and Todo Dia by Carrefour and Walmart respectively in the recent years • In order to overcome the distance factor, Carrefour has experimented with schemes such as reimbursing bus or taxi fares of shoppers

• Most Brazilians nurture a seemingly conflicting desire: to choose from a full range of products, including high-end ones, whether or not they intend to purchase the high-end products

Offer limited product variety across 3 distinct price range

Excellent Instore service is extremely critical to the Brazilian customer

• Key reasons being • A need to see a well-known branded product & use it as a reference price for products that they would actually purchase • The opportunity to treat themselves every now & then or a desire to impress neighbors during some special occasion etc. • A survey of retailers revealed that a local retailer offers an average of nearly 40 percent fewer SKUs than some of major players do. With this, the local retailer‟s price architecture meets the consumers‟ need for choice while minimizing confusion by clearly differentiating among good, better, and best products by price, without offering a multitude of SKUs in between those quality levels • Shopping trips are the only opportunities that many consumers have to be served; hence, they value customer service highly • Shoppers expect the human touch that they find at their neighborhood stores, where salespeople greet them warmly by name and extend credit without collateral or other formalities

• This implies that retailers need to pay a lot of attention to services such as bagging, counter service, and taste tests, as well as a sense of warmth and fun rather than the décor, lightning, fixtures and flooring

Source: McKinsey survey of about 1000 consumers from São Paulo, Rio de Janeiro, Belo Horizonte, Porto Alegre, and Recife, 2005

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At the same time, the Brazilian customer is price-sensitive, addicted to promotions and has an affinity for eco-friendly products (2/2) Brazilian customer is extremely priceconscious & addicted to promotions

• Brazil‟s consumers are extremely price conscious- they check prices in a number of stores before buying & are seemingly addicted to promotions; some customers might stay in stores just to wait for announcements of on-the-spot offers • Retailers encourage this kind of behavior by offering great promotions, thereby perpetuating a vicious cycle of “cherrypicking”. However, frequent promotions actually seem to fuel confusion among customers & possibly distrust- a phenomena that a store should guard against

• Companies are luring shoppers to stores stocked with free samples, which is a part of their strategy to test customer tastes and build market share

Market testing with free samples

Retailers are testing store formats

• The companies introduce products ahead of their release and shoppers are enrolled. They are involved in testing range of products (such as cosmetics, foods, and consumer products such as mobile phones) in the free sample stores • This offers retail companies a low-cost research tool for understanding consumer tastes and developing appropriate product mix for better success of product

• Retailers are experimenting- testing store formats in states of Rio Grande do Sul, Parana etc. before launching them in Sau Paulo

• For ex, in 2009, Carrefour opened 3 convenience stores in São Paulo after a successful trial of this format in Porto Alegre, Rio Grande do Sul

• Brazilian consumers are inclined towards environmental concerns (such as how products are manufactured or disposed of)

Emphasis on Eco-friendly

• Retail companies have altered their marketing strategies to tap the needs of this group. Some companies have started selling eco-friendly products, reduced the use of plastic bags and are providing recycling collection centers

Source: McKinsey survey of about 1000 consumers from São Paulo, Rio de Janeiro, Belo Horizonte, Porto Alegre, and Recife, 2005, news runs, company websites

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Consumer Insight - Pet Products in Brazil

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All 31 prefectures in the city have monthly income higher than Brazil’s avg.; an indicator of affordability of pet by city dwellers City of Sao Paulo’s Regional Break-up by Average Monthly Income

Region

AMI

Population

Region

AMI

Population

1 – Butanta

2,764

384,069

17 – Santana

1,435

304,062

2 – Ipiranga

2,197

429,299

18 - Vila Maria

1,435

287,886

3 – Lapa

2,764

255,185

19 - São Mateus

937

436,329

27 28

4 - Vila Prudente

1,352

520,670

20 - Jaçanã

1,435

276,628

5 - Vila Mariana

2,197

294,627

21 – Mooca

1,352

286,598

6 – Pinheiros

2,764

233,563

22 - São Miguel

937

410,514

7 – Penha

1,352

476,489

23 - Itaim Paulista

937

399,140

8 - Capela do Socorro

928

672,901

24 - Cidade Ademar

928

402,713

9 – Se

1,789

328,597

25 - Casa Verde

1,177

313,026

10 - Campo Limpo

928

578,857

26 – Aricanduva

1,352

258,203

11 – Pirituba

1,177

442,722

27 – Guaianases

937

291,193

12 - M´Boi Mirim

928

544,446

28 - Cidade Tiradentes

937

242,077

13 – Itaquera

937

525,337

29 - Ermelino Matarazzo

937

210,709

• Ipiranga – Second-highest AMI, High population

14 – Freguesia

1,177

416,743

30 – Perus

1,177

148,226

• Vila Prudente/Sapopemba – Moderate AMI, High population

15 – Jabaquara

2,197

213,862

31 - Parelheiros

928

148,239

• Se – Moderate AMI, Moderate population

16 - Santo Amaro

2,197

207,421

30 20

17 25

29 22

3 9 1 10

26 4

Up to R$1,200

R$1,200 – 1,500 R$1,500– 2,000

8 Over R$2,000

Ranks reflect prefecture’s monthly income (1 being the highest) and have been arrived at by multiplying prefecture’s average monthly income and its population

Five regions are selected, with at least one from each income slab based on population and affordable income level to provide a suitable mix • Butanta – Highest AMI, Moderate population

• Capela do Socorro – Low AMI, Highest population

AMI = Refers to Average Monthly Income per household

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Despite a relatively higher pet ownership level, Brazil’s pet population continues to grow Cat & Dog Penetration – Country Comparison

Dog Ownership in Brazil (% of Households) 57.5% 56.0% 54.8%

2005

54.9%

2006

2007

2008

2009

Cats & Dogs per Household

56.4%

y = 0.0161x + 0.2384

1.60

R = 0.3373

1.40

1.20 1.00 Brazil

0.80 0.60

Russia

Japan

0.40

Australia Germany

0.20

China India

0.00 0

Per Capita Income ($ '000) Source: Frost & Sullivan, Euromonitor, Gardenex, Australian Companion Animal Council

Source: Euromonitor, IBGE

Key observations • Brazil has the second largest pet population estimated at ~80 million. Pet population estimates for Brazil vary from agency to agency. According to Anfalpet, the association of pet food manufacturers in Brazil, population of pets stood at 78 million at the end of 2009. According to Euromonitor, the population of pets in Brazil was estimated at 80 million • Per capita pet ownership in a country is found to be moderately correlated to the per capita income of that country. Based on a regression analysis of the pet ownership and per-capita income variables for a few countries, Brazil‟s per capita pet ownership is observed to be above the levels that countries with similar per-capita incomes would have, indicating that pet population growth may decelerate Source: Frost & Sullivan, Euromonitor, Gardenex, Australian Companion Animal Council, IBGE

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Fundamental drivers of pet population growth have been robust

Couples without children

Million

Single-Person Households

Trends

Million

Drivers

Comments

5.5

5.8

6.2

6.7

5.2

6.7

• A characteristic feature of Brazil‟s social set-up – 12% of households are single-parent families • Relatively lower divorce rate but incidence of the same is increasing; most are single by choice

4.3

4.5

4.9

2001

2002

2003

2004

2005

2006

2007

2008

2009

8.5

10.2

6.5

7.5

8.0

9.6

7.2

8.9

6.8

2001

2002

2003

2004

2005

2006

2007

2008

2009

• Young couples increasingly delay births • Share of households without children has increased from 14% in 2001 to 17% in 2009 and is expected to continue to increase

Apartments (lower share)

9.0

10.3

12.1

14.1

1990

1995

2000

2005

3.1

3.2

3.3

3.4

2001

2002

2003

2004

16.8

2010E

• One of the major drivers of pet adoption • Population of persons above 60 years has almost doubled between 1990 and 2010 • Trend is likely to intensify over the next 10 years

2015F

2020F

3.7

3.8

3.9

4.0

2005

2006

2007

2008

2009

Million

Aged People (60+)

Million

24.3 20.3

• Homeownership in Brazil, stands at a respectable 74.4% (Source: IBGE, 2008) • At 4 million, apartments, constitute less than 7% of dwellings in Brazil indicating a preference for single-family homes • As compared to apartment-owners that face space constraints, owners of single-family homes have a greater propensity to own pets

Source: IBGE

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Pet retailing strategy needs to focus on the Class C household which accounts for ~60% of pets in Brazil Pet Population in Million by Income Segments

48.5

11.6

Class A / B

Class C

10.1

Class D

• Ownership of dogs in class A/B population is about 50%

• Ownership of dogs in class C population is about 60%

• Ownership of dogs in class D population is about 55%

• Pet humanization trend is very strong amongst the top strata

• Class C, forming the middle class of Brazil, maintain small pets which are convenient to maintain in space crunched urban areas

• Class D is the lower middle class of Brazil

• Rich people treat their dogs like children; and some fine restaurants are happy to have them as customers • Class A customers typically buy accessories from brands such as Louis Vuitton, Gucci and Hermes

• Class C customers typically buy packaged pet food and are known to switch over from private label products to branded products

13.1

• Class D pet owners usually buy private label pet food or feed them with homemade food and leftovers

=83.3 Mn

Class E • Ownership of dogs in class E population is the same as class D at about 55%

• Class E constitutes the poor sections of the population • These consumers feed only homemade food and leftovers to their pets

• These consumers are price sensitive and do not mind switching brands for attractive discounts

Source: Euromonitor, SGS Estimates, PetFoodIndustry.com

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Consumers are price-sensitive w.r.t pet product purchases; economy brands dominate pet food demand but a clear preference for MNC brands exists Share of Top Brands by Retail Sales (2009)

Share of Top Brands by Retail Sales (2009)

14 Other P et Fo o d

R$ Billion

8.9 7.7

9.5

10.1

11.4

10.7

12.0 CAGR 6%

8.1

6.4 6

4.9

5.6

CAGR 13%

23.8

Top Pet Food Companies

Do g & Cat Fo o d

~72% of Retail Sales 18.1

8.5

8 6.2 3.4

2.1

1.7

2.3

2.1

0 2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

12.9

2015

Standard, 23% Economy, 65%

Permium, 8% Super Premium, 4%

Top Pet Food Brands

~39% of Retail Sales

Pet food market by brand classification (2009)

6.5 4.8 3.8

3.5 2.6

Source: Euromonitor, SGS Estimates, ANFAL Pet, PetFoodIndustry.com

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Factors that contribute to the dominance of neighborhood pet-shops STRENGTHS

SIGNIFICANCE

OBSERVATION

Personalized Service

Our primary research indicates that a typical Brazillian pet owner, seeks personalized attention while shopping for pet products or services. Greetings and the personal touch with which proprietors of these firms handle the customer‟s pets address such needs. It is not possible for super market staff to offer such attention as pet may constitute a small part of their overall sales

Expertise / Product Knowledge

Pet shops which typically also have veterinary doctors, do a better job in assisting the customer in selecting the right brand of food for his/het pet. Pet shops also score over supermarket and in terms of product knowledge

Variety

Our primary research indicates that pet-shops have a better SKU selection than most channels. Imported or difficult to find brands a re more likely to be available at a pet-shop than a supermarket. In addition to this pet food manufacturers (Royal Cannine- 2.2% share, Total Alimentos-8.7% share in 2009) indicate that they generally avoid supermarkets owing to their demands for increased discounts

Convenience

Pet shops emerge as a more convenient option for pet product purchases, given their proximity to the customer and also because of the value-added services that they offer e.g. pet taxi, pick-up and drop etc. Convenience is fast emerging as the norm for Brazillian retail and most operators are launching convenient formats to address this need. Apart from convenience pet-shops also offer credit schemes to customers

Bundled Offers & Price

Primary with superstores indicated that pet shops often attractive bundled offer encompassing food, services and equipment needs for a month at attractive flat prices. Pet shops often distribute free samples of pet food so as to enable the owner to recognize their pet‟s likes and dislikes. Pet shops are also touted to be cheaper than supermarkets owing to the higher taxes on pet food that informal setups can avoid. We could not independently validate this during the course of our research

One Stop Shop

Unlike supermarkets which offer only pet foods, pet shops offer all pet products, pharmacy products and pet services including bathing and grooming, vet services, taxi services, day boarding and hotel services under one roof thereby providing a one-stop shop for the customers

Source: Primary Research, Sutherland Compilation

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