Manufacturing turns to foreign trade and new markets to adapt to a changing environment

It has been a goal of successive Colombian governments to diversify the economy by developing the manufacturing sector. To a certain extent, this endeavour has been successful. Colombia has a stable industrial base with a presence in a range of industries from processed foods to petrochemicals. Some of these sectors have sustained robust growth during the past decade and have developed export channels targeting regional markets. However, other industries have not been able to overcome a number of challenges that virtually all Colombian manufacturers must contend with. High transportation costs due to outdated roads and challenging topography are foremost among these. More recently, increased international trade has brought lowcost goods to the domestic market, revealing, rather quickly, which of Colombia’s manufacturing sectors are equipped to compete in global markets – and which are not. An additional challenge has been the rapid increase in the value of the Colombian peso, which has undermined the competitiveness of exports.

Competitiveness

The challenges have had an impact on manufacturing sectors, with some companies’ operations quickly losing economic viability and others able to seize on increased opportunities for foreign trade. There have been success stories from fast-moving consumer goods (FMCG) industries. The cosmetics industry, for example, has emerged as a leading exporter in the region and certain automobile assemblers have found profitable export niches. However, despite these successes, there is a climate of concern regarding the future competitiveness of manufacturing. In 2013 these fears seemed to manifest themselves when, in June and July, two multinationals closed longstanding manufacturing operations. Michelin, the French tyre maker, was first. In June it announced it would close all industrial operations in the country, citing the falling price of the dollar and the Brazilian real relative to the peso, and increased imports of tyres to the domestic market that were priced under Michelin’s locally produced ones. Michelin’s Colombian branch, Michelin Colombia, said that in the past 15 years it had accumulated losses of COP300bn ($150m) and made investments of COP261bn ($130.5m).

Bayer was the next multinational to close shop, after 58 years of operation. The German company produced Aspirin and Alka-Seltzer, among other products, at its plant in Cali, which it closed, moving production capacity to facilities in Guatemala and Mexico. Bayer’s other plant, in Soledad, continues operating normally.

These closures came as a surprise to most and contributed to a slight contraction in manufacturing output in 2013, but private companies and the government have put measures in place over the past few years to adapt to the new realities facing Colombian industry.

Government Initiatives

Manufacturing contributed 14% to Colombia’s GDP from 2009 to 2011, a figure which dropped to 12% by 2013. As industry has not grown in concert with the economy at large, the government has implemented several programmes to buoy domestic manufacturing. The first is a permanent public-private partnership (PPP) known as the Productive Transformation Programme (Programa de Transformación Productiva, PTP), an organisation through which the government supports a selection of sectors in manufacturing, agriculture and services.

The PTP’s mandate is broad, encompassing promotion, subsidies, training and modernisation, which may take the form of, for instance, Kaizen workshops which are based on a Japanese technique aimed at improving quality and productivity through worker-directed continuous, incremental changes and the elimination of waste. The organisation also acts as a conduit between business executives and government officials, facilitating dialogue so that government policies can be brought into line with industry priorities.

When the PTP was formed, the objective was that it should direct its resources at those industries that could become competitive on a global level and help to move Colombia’s economy forward in terms of both growth and modernisation. However, the programme has been criticised for being involved in too many sectors. The PTP’s manufacturing group includes 11 sectors: cosmetics and cleaning products, motor vehicles, auto parts, textiles, clothing, leather goods and footwear, metal-mechanics, metallurgy, organic oils and biofuels, chocolate and candy, and dairy.

Nine additional sectors comprise the agriculture and services groups. Some of the manufacturing sectors fit with the original goals of the PTP. Cosmetics, for instance, is a growing industry with a bright future (see analysis). But, for some of the included sectors, such as textiles, it is more difficult to make the case that they will be vital to the future of Colombia’s economy.

PIPE

In April 2013 the government of President Juan Manuel Santos announced a scheme called Stimulus Plan for Production and Employment (Plan de Impulso a la Producción y el Empleo, PIPE). Through Bancóldex, a state-owned bank whose mission is to support commerce, industry and the growth of exports, PIPE promised to make available COP5trn ($2.5bn) in loans to help lift industry out of its slump. The plan also reduced payroll taxes and deferred payments of import tariffs on raw materials and equipment. Just before the programme’s first anniversary, Santiago Rojas, former minister at the Ministry of Commerce, Industry and Tourism (Ministerio de Comercio, Industria y Turismo, MCIT), which oversees the PIPE, announced that, after disbursing COP440bn ($220m) in 2013, a new tranche of COP1trn ($500m) would be made available through the programme. The president of Bancóldex, Luis Fernando Castro Vergara, said that these resources “will have favourable conditions in terms of rate and duration and will enable businesses to restructure their debt”.

Free Zones

The establishment of a system of free economic zones (FEZs), or free zones, may be the most effective and sustainable of the government’s industry-promoting initiatives (see analysis). In Colombia, FEZs are specific areas, such as specially designated industrial parks, or facilities, such as ports or factories, that provide preferential tax and Customs treatment to their occupants. Companies wishing to operate within an FEZ must meet certain investment and employment requirements. The FEZs have been an important draw for domestic and foreign investment in new ventures and have been effective at attracting foreign companies to Colombia to set up manufacturing bases for products to be exported throughout the Americas.

Free Trade

Colombia’s growing network of free trade agreements (FTAs) have been an integral part of the FEZ model. In the case of Colombia’s FTA with the US, for example, only 30% of the value of a product must be of Colombian origin for it to qualify for preferential treatment. As a result, foreign companies are able to carry out some portion of manufacturing in Colombia — within an FEZ or otherwise — and derive the full benefit of the country’s FTA. Trade deals have also helped Colombian industry modernise by eliminating tariffs on equipment and machinery. However, overall, free trade has been a mixed blessing, at least in the short term. “Since Colombia has opened itself to globalisation, it is attracting foreign companies. Gradually, local companies are discovering the impact of the entrance of new competitors and they are looking to expand abroad. They’re finding that Central America is the best option,” Andrés Ortega Méndez, the general manager at Pintuco, a Colombian paint manufacturer, told OBG.

These are natural markets for expansion of Colombian industry for several reasons. They are nearby, decreasing shipping costs; some do not have substantial industrial bases of their own; and, since they are small economies, fewer multinationals have an established presence. As Rodolfo Ramírez, the president and managing director at PPG Industries Colombia, a subsidiary of PPG Industries, an American supplier of paints, optical products, chemicals and glass, told OBG, “Colombian industry has to diversify and start thinking about leaving the domestic market and selling abroad. However, companies should focus on small countries where there are no big competitors for them.”

Recently Colombia signed FTAs with Panama and Costa Rica as part of those their bids for accession to the Pacific Alliance (PA), the free trade and economic integration bloc comprised of Mexico, Colombia, Peru and Chile. The PA creates a fairly unrestricted economic zone with total output to rival that of Brazil, and the members have shown to be committed to maintaining open markets, accommodating foreign investment and generally eschewing protectionist policies. Each of these measures may challenge certain segments of Colombian manufacturing in the short term, but they may stave off the kind of industrial stagnation experienced in Brazil’s more closed economy in recent years. Colombia also has an FTA with the EU, which came into effect in 2013. The effects of the agreement were only beginning to be felt in the first half of 2014.

Currency Exchange

Colombia’s pro-business governments under presidents Álvaro Uribe (2002-10) and Santos (2010-present) have attracted significant inflows of foreign direct investment (FDI), especially to the extractive industries. FDI increased from $3bn in 2004 to a record $16.8bn in 2013.

One consequence of the rise in capital inflows has been a strengthening Colombian peso. In 2012 the peso appreciated 9%, causing headaches for exporters. In response, the Colombian Central Bank began buying dollars and reducing foreign debt. Meanwhile, PIPE created incentives for pension funds to increase their holdings of foreign assets. These measures were successful in weakening the peso through the first three quarters of 2013, during which time the currency depreciated by 6.3%. But it climbed again in the first quarter of 2014, taking back much of the progress made the previous year. In light of the rally, the central bank announced in June that it might double purchases of dollars in the third quarter, buying as much as $2bn, compared to the $1bn it bought from April to June 2014. The central bank has made clear it is committed to controlling appreciation, which is welcome news to Colombian manufacturers despite the fluctuations.

Logistics

High transportation costs pose one of the greatest threats to Colombian industrial competitiveness. The roads are inadequate and no river or rail systems have been developed that can handle large-scale shipping (with the exception of several private railroads operated by mining companies). According to the US Ministry of Transportation, Colombia has the second-highest transportation costs in South America. The World Economic Forum’s “Global Competitiveness Report 2013-14” ranked the quality of Colombian roads 130th in the world. The ranks for quality of port and air transport infrastructure were 110th and 96th, respectively. Quality of overall infrastructure was ranked 117th.

A study by the World Bank in 2012 found that it cost the same amount to ship a tonne of cargo from Shanghai to the Colombian port of Cartagena (a voyage that includes a Panama Canal crossing) as it did to transport a tonne from Cartagena to Bogotá. In a country that struggles to compete with many foreign industrial markets in terms of labour and energy costs, it is a cruel blow that imported products are hardly marked up, on a relative basis, for cross-ocean shipment.

Infrastructure Obstacles

The governments have tried to deal with the infrastructure problem for years, but, in the face of extreme social and security issues, the political will was sometimes lacking. As security has improved, following a decade-long offensive against guerrilla groups, the Santos government has made road construction a high priority.

Through a series of PPPs and auctions of concessions, the government intends to attract $20bn of private investment. Auctions for the main highway building concessions, which are part of the 4G infrastructure project, were held through the first half of 2014 and attracted numerous bidders, suggesting that the financial terms and regulatory framework laid out by the government are attractive to construction companies. This is a promising sign given that in 2013 several obstacles to infrastructure development appeared poised to keep away investors. Infrastructure projects of all kinds – including those in the mining, hydrocarbons or electricity sectors – tend to face environmental and social roadblocks. Colombia has enormous biodiversity and challenging topography, which have led environmental licensing agencies to be exacting in evaluating new projects. Also, Colombia’s indigenous and black communities have constitutional rights protecting the use of land they have traditionally occupied. As a result, companies carrying out infrastructure projects must engage or consultations) with any communities that may be affected by a project. These consultations, which are not clearly defined by Colombian law, can lead to holdups (see the Energy chapter). Lastly, the exercise of eminent domain in Colombia is inefficient, which can be another source of delays.

None of these problems is a dealbreaker. Mining, hydrocarbons and electricity projects routinely confront them and carry projects to successful completion despite the delicacy and time involved. However, delays and unfinished business when it comes to highway projects have kept Colombian manufacturers from staking their plans to the infrastructure programme.

According to Iván Villegas, the general manager of engineering firm Proyekta, “It is logical to have the industry located on the coast near the ports but for cultural reasons this was not the case in Colombia. Here people are very attached to their region and each one has a different way of doing business from the other.” However, this is changing. As companies increasingly look abroad for new markets, industry is moving away from the country’s interior and population centres. “Industrial facilities, in terms of both manufacturing plants and distribution centres, are moving towards the coast to be closer to the ports and decrease logistics costs,” Héctor Iván Franco, a manager at Faismon, a company providing industrial equipment, infrastructure assembly and heavy machinery, told OBG. “There will still be work in big cities like Bogotá, Medellín and Cali, but the trend, until the roads are finished, will be the development of the coast.”

Meanwhile, Colombia’s product quality has improved with the emergence of testing laboratories. Claudia Patricia Betancur, the director of Laboratorio Electromecánico & Metrología Qtest, told OBG, “In 2005 in order to improve Colombia’s product quality, the first law for control of electrical products was passed. In 2013 it was extended to lightning and telecommunications, while there are future plans to expand the regulation for toys, wheels, brakes, safety and insurance.” According to Betancur, “In the Andean region, Colombia pioneered the RETIE, a regulation manual for product testing. This trend has now extended to Equator and Peru but, due to the high costs of specialised machinery, testing laboratories in the country are servicing the region.”

Motor Vehicles

The automotive industry is among the segments that have suffered from increasing foreign trade in recent years. Until a few years ago, Colombian plants produced the majority of cars sold in the country. Today two-thirds of newly purchased cars are imports, a fact that has led to contracting domestic production and a scramble to reconfigure the industry.

The motor vehicle industry (excluding motorcycles) consists of four assemblers and an auto parts segment. Until the signing of numerous trade agreements, the industry was insulated from external competition, leaving it ill equipped to deal with an influx of imports. In 2007 the three assemblers then operating (the fourth arrived the following year) produced 181,941 vehicles, including cars, trucks, buses and campers. By 2009 this figured had halved. Then, after recovering in 2010 and 2011, it contracted again in 2012 and in 2013, when production stood at about 128,000 vehicles. With the exception of Hino, the assembler that arrived in 2008 and which is the industry’s smallest player, all of the assemblers have had challenging times in the past seven years, although to varying degrees. Colmotores, which assembles General Motors vehicles, and Sofasa, an assembler for Renault, have traditionally been the biggest producers. Both saw production dip and then recover, in line with the global recession and recovery. But after Colmotores suffered a 25% contraction in 2012, Sofasa emerged as the biggest assembler, with about 75,000 units of production in 2013, a figure that approached the 78,000 vehicles it produced in 2007.

Meanwhile, the third major assembler, Compañía Colombiana Automotriz (CCA), a Mazda assembler, has seen its business unravel since 2007, when it produced 34,000 vehicles. Since then, production has declined every year except 2010, and in May 2014 the company closed its plant.

CCA’s president, Fabio Sánchez, told biathat the causes of the company’s decline have been increased competition from imports on the domestic market and the loss of Venezuela as an export market, as the economy closed and the Venezuelan bolivar was devalued. CCA called the plant closure temporary, but it was unclear when it might reopen.

Export To Recover

By contrast, Sofasa has set itself apart by successfully developing its export businesses, a measure that is seen as crucial to the survival of Colombian vehicle assemblers as competition intensifies in the domestic market. The key is finding and exploiting segments that are not served by the massive auto industry to the north. “We have to look for market niches, vehicles that aren’t being produced in Mexico,” Camilo Llinás, the executive director of the Association of Colombian Auto Parts Manufacturers (Asociación Colombiana de Fabricantes de Autopartes, Acolfa), told OBG. This reality has put Sofasa at an advantage since Renault has no manufacturing presence in Mexico, which has enabled Sofasa to exploit the market niches Llinás refers to. Beginning in 2012, Sofasa produced 24,000 Renault Duster SUVs for export, mainly to Mexico. In 2013 production expanded and Sofasa’s exports accounted for 46% of all production.

Doubling Down At Home

Meanwhile, Colmotores has pursued a more aggressive and somewhat counterintuitive strategy. Beginning in 2012, Colmotores started building a $70m plant in Bogotá. Because of the large investment in the project, Colmotores was able to establish the plant as an FEZ, thus securing a 15% tax rate and preferential Customs treatment. The new plant is a production factory, not an assembling plant, and has capacity to produce the body panels for 60,000 Chevrolet Cobalts and Sails per year, two models that Colmotores began assembling in 2012. The investment was met with some surprise among industry analysts, as the conventional wisdom has been that Colombia is better suited to assembly (because finished vehicles, which are expensive to ship, can be sold on the domestic market or in nearby countries) than component production (where cost is king). Production at the plant is planned to ramp up capacity from a base of 20,000 frames per year. Beginning in 2014 or 2015, body panels for the Sail will be exported to Ecuador where General Motors also assembles that vehicle.

Government Support

Part of the PTP, the auto industry is one of the many sectors the government has attempted to stimulate. However, taking action on behalf of the industry is a complicated matter because, on some issues, the interests of the industry’s two halves – assemblers and auto parts manufacturers – are diametrically opposed. In late 2013 the government indicated that it would prioritise the assemblers over the parts producers when the finance minister announced that the government was studying the possibility of reducing or eliminating tariffs on auto parts, as Reuters reported. Such a move would bolster the competitiveness of Colombian assemblers at the expense of domestic auto parts manufacturers. This conflict speaks to the challenges the government faces in trying to promote a wide range of manufacturing sectors instead of focusing on a few promising ones.

Motorcycles

While the auto industry has faced new challenges, the domestic motorcycle industry has experienced virtually unimpeded growth in recent years. The strengthening peso has brought motorcycles within reach of many consumers who still cannot afford cars, which has led to motorcycles coming to comprise half of Colombia’s total motor vehicle fleet. Annual sales, which topped 600,000 in 2013, are about double those of cars. Of the motorcycles sold in Colombia every year, the great majority – 553,000 in 2012 – are produced domestically. To reach this level of production, the industry has been ramping up capacity every year to keep pace with demand, which has grown at double-digit annual rates. Foreign firms have taken notice of the growing demand. Hero MotoCorp, an Indian motorcycle and scooter manufacturer, will be the next big player to set up operations in Colombia. The company plans to invest $70m in a plant in the Parque Sur FEZ in the department of Cauca on the southern Atlantic coast. The plant is scheduled to begin operating in 2015 or 2016 with production capacity of 78,000 units per year, which will increase to 150,000 units by 2020. To date, Colombian motorcycle assemblers have been focused on meeting the growing domestic demand and have not faced significant competition from imports.

Textile & Apparel

The story of the Colombian textile and clothing industry is a familiar one in Latin America: a legacy industry struggling to compete as cheap Asian goods flood the market.

During the past decade, clothing production has grown at an average annual rate of less than 2% and in 2013, production contracted by 5.7%.

Beginning in 2012, as competition from Chinese products intensified, the industry began lobbying the government for protectionist tariffs. In January 2013 the government acquiesced and issued decree 074 of 2013, which implemented onerous levies on imported clothing and shoes. (This decree was later supplanted by decree number 456 of 2013.) The executive order implemented tariffs of 10% plus $5 on clothes with a value equal to or less than $10 per kilogram, and of 10% plus $3 for pairs of shoes priced at less than $7. The tariffs were slightly less severe for items above these price thresholds. According to the government, the steep tariffs on low-cost articles were meant to punish importers who understated the price of goods.

Foreign apparel makers did not see it this way and, in June 2013 Panama filed a complaint with the World Trade Organisation (WTO) about the new tariffs, with China, the US, the EU, Ecuador and others listed as third parties. Despite the complaint, which is still ongoing, the Colombian government extended the tariffs in January 2014. As of mid-2014 it appears that the tariffs may be having the intended effect. In the fourth quarter of 2013, for example, clothing production grew by 3.2% year-on-year. In the period from January to April 2014, production grew 9% relative to a year earlier.

Construction Materials

Elsewhere in industry, the various construction materials sectors are expecting a boost in demand as the government’s infrastructure plan moves forward. Also supporting demand is Colombia’s widening housing deficit, which the public sector plans to address (see analysis). Colombia’s cement industry is poised to take full advantage of rising demand because, as is the case in most countries, domestic cement producers dominate the market. Cement is usually produced close to markets where it is consumed because of the high cost of transporting it. Colombia’s steel industry, on the other hand, has been among those that have suffered due to growing international trade. Like the clothing and textiles manufacturers, steel producers requested and received protectionist tariffs, which were implemented in 2013. Shortly after the tariffs were put in place, several countries with export interests in the Colombian steel market threatened to file a complaint with the WTO. However, before any action was taken, the government suspended most of the tariffs after concluding that the domestic industry’s poor performance was not the fault of irregular or unfair trade practices. The problems may simply be the result of a lack of internal efficiency.

The ramping up of road construction has also expanded an opportunity for Colombia’s miners. Contained within many mining concessions are sand, gravel and other raw construction materials that some companies have begun exploiting as a revenue stream, as road construction firms look to source materials locally.

Fast-Moving Consumer Goods

For several years, FMCG have been among the most successful products manufactured in Colombia. The cosmetics industry, in particular, has grown quickly and continues to show potential (see analysis). In the past few years the sector has accomplished many of the goals laid out by the PTP, of which it is a part. The sector has used the domestic market as a springboard to develop a viable export business; it has attracted significant FDI from multinationals in both production and research and development; and it has consistently outpaced the economy at large in terms of growth. The markets the industry has targeted for export are Central American countries and neighbouring South American ones. In this way, the sector has leveraged Colombia’s location at the hub of a number of small and mid-sized markets without entering into competition with industrial giants by vying for market share in Mexico or the US.

Processed Foods

Also in the category of FMCG, the processed and packaged foods industry has faced challenges in recent years, but several segments, including chocolates and dairy products, have managed to sustain strong growth. The main challenge has been the closing of the Venezuelan economy. Venezuela had been the Colombian processed food industry’s number-two export destination after the US. But Colombian exports to the country have fallen to a third of their level five years ago. The situation has been exacerbated by Colombian companies willingly decreasing their exposure to the Venezuelan market since problems have arisen in collecting payments there. Meanwhile, new regulations put in place by the US Food Safety Modernisation Act have lowered Colombian exports to the industry’s number-one export market since the law was signed in 2011. Colombian food producers have also faced intensified competition on the domestic market since ratifying FTAs with the US and the EU. The greater economies of scale and, especially in the case of the US, significant agriculture subsidies that foreign firms benefit from present challenges to Colombian producers trying to compete on price.

Milk And Chocolate

Nevertheless, chocolates and dairy products, both of which are included in the PTP, enjoyed strong growth. Production of chocolates went up by 8.5% in 2013 and exports increased by 13% compared to 2012, reaching $390m. The sector benefits from a local supply of cacao provided by Colombian farmers. Throughout the country cacao is cultivated on more than 150,000 ha, with average annual production of 400 kg per ha. The dairy processing industry also benefits from the cost savings associated with sourcing inputs locally. Colombia produces 6.5bn litres of milk per year and, according to the PTP, there is additional capacity that can be tapped if the industry continues growing. Colombia is the third-biggest milk consumer in Latin America, and the consumption value has risen in the past decade to $2.8bn in 2013, in concert with demographic expansion and economic growth. Domestic production has kept pace with demand, growing 8% in 2012 and 9% in 2013.

Petrochemicals

The fortunes of Colombia’s petrochemicals segment are tied to the performance of industry as a whole. As a result, in 2013 petrochemicals output declined. Despite the downturn, demand for plastics is expected to pick up again in 2014, and first-quarter results from some manufacturing sectors suggest the beginning of a turnaround. Additionally, the success of FMCG is a welcome development for the petrochemicals industries, as these sectors will increase demand for plastic packaging. Infrastructure and residential housing projects are also expected to boost demand for plastics, such as PVC (see analysis).

Although higher demand will buoy the petrochemicals industry, growth will be capped in the short term because of current ceilings on production capacity. In 2013 petrochemical production capacity stood at 500,000 tonnes per annum (tpa) of polypropylene, 400,000 tpa of polyvinyl chloride, 120,000 tpa of ethylene, 60,000 tpa of low-density polyethylene, 45,000 tpa of benzene, 45,000 tpa of polyethylene terephthalate, 35,000 tpa of xylenes and 20,000 tpa of toluene. These capacities will not be able to expand until Colombia’s refining capacity increases.

For the size of the hydrocarbons industry, refining capacity is low. To address the shortfall, Ecopetrol, the partially state-owned oil and gas firm, has made sizeable investments in expansion projects at the two biggest refineries. Ecopetrol has invested $3bn in the Barrancabermeja-Santander refinery to boost capacity by 50,000 barrels per day (bpd) to 300,000 bpd. A $6.5bn investment in the Cartagena refinery known as Reficar will double capacity to 180,000 bpd by 2015. Propilco, Ecopetrol’s petrochemicals subsidiary, will be able to boost production as the refinery expansions come on-line. Currently Ecopetrol provides Propilco with 130,000 tonnes of propylene per year. This figure is scheduled to increase incrementally in the coming year until it reaches 330,000 tonnes by 2018.

Retail

A benefit of the strong peso has been increased buying power among consumers. The stronger currency and the emergence of a new middle class, which now accounts for a third of the population, have driven a surge of foreign investment in Colombian retail (see analysis). Several of the big Chilean retailers, such as Falabella, Ripley and Cencosud, have introduced their chains. Malls have expanded rapidly as increased buying power has led to the development of a taste for international brands, a phenomenon which is relatively new outside the upper strata of Colombian society. Informal retail still accounts for as many as half of retail transactions. However, increased banking participation and an appetite for e-commerce are laying the groundwork for the modernisation of the sector.

Outlook

Colombian industry is at a crossroads, which is demonstrated by the significantly divergent performances of various sectors, including closely related ones. After developing in relative isolation, the manufacturing sector has now undergone something of a stress test as foreign goods have entered the market. Most industries will need to reconfigure, as some have already done, in order to grow, or even survive, in the new environment. However, opportunities also abound, for trade deals are two-way agreements and, as segments such as cosmetics have found, there is a place in the regional market for Colombia, a mid-sized exporter, to meet its neighbours’ growing levels of consumer demand. The future competitiveness of Colombian industry may depend on manufacturers’ ability to seize this opportunity and emerge as the lead producers in the region.