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Chasing the Latin American retail consumer

Chasing the Latin American retail consumer

Posted by Juan Gavasa on May 27, 2014

Like many of today's young entrepreneurs, Galperin would never have been able to launch his business if it weren't for his business school professor Jack McDonald, who helped him woo venture investors like John Muse, co-founder of the Hicks private equity fund, JPMorgan Partners and Flatiron Partners.

Although the venture began in Argentina as an auction site, it quickly expanded to Brazil, Mexico and other Latin American countries. By 2001eBay acquired 19.5 percent of MercadoLibre, and Galperin's venture became eBay's exclusive partner in Latin America.

It's no accident that the company's name means free market in Spanish.Observers say that like other e-commerce players in emerging markets, it has helped opened access to goods and services of all kinds. Today Latin American consumers perform 2,000 searches per second on the site, buying everything from cars to clothing.

The rewards of operating in the emerging Latin American retail market are great. There is lots of room to grow as the ranks of the middle class increase: In early 2013, Brazil and Argentina had e-commerce penetration rates of less than 6 percent, compared with about 14 percent in the U.S., according to Morgan Stanley. Yet the risks are also enormous.

Running an e-commerce platform in Latin America means coping with the region's political instability, as well as the laws and regulations that vary widely between countries and rarely take Internet businesses into account. Another major issue is currency volatility. Analysts expect Venezuela's currency devaluation will tamp down MercadoLibre's growth and profit margins later this year.

So far, U.S. e-commerce giants have only dipped their toes in the waters of Latin America, but competition in the sector is expected to heat up. While the eBay alliance ended in the fall of 2006 with a non-compete agreement, other companies are eyeing the marketplace.

Galperin spoke with CNBC about his future plans for the company and the power of e-commerce to transform economies. The interview was edited and supplemented with information from the company's public filings. MercadoLibre reported its first-quarter earnings earlier this month: net revenues of $115.4 million, up 12.3 percent year-over-year, and earnings per share of $.69, up 73 percent.

CNBC: What is the most important source of revenue growth for the company over the next five years?

Galperin: The shift to mobile is huge, and it is happening really, really fast. Twelve percent of our gross merchandise volume comes from mobile phones. It's a huge opportunity, but it's a huge execution challenge in terms of continually writing the software to adapt all of our services to the new formats. We believe over 50 percent of our business will come from mobile five years from now.

We also want to grow our small-business service business through our MercadeLibre Marketplace. In fiscal 2013, it had 5.1 million sellers and 83 million items sold. We expect the marketplace to grow as we cross-promote our services, like MercadoShops, which allows small businesses to open their own websites within the ecosystem, and it lets users create their own e-commerce website, integrated with MercadoLibre's ecosystem and MercadoPago, an online payment system that allows our users to send and receive financial payments.

CNBC: Any plans to expand into the U.S. market?

Galperin: No. We are focused on expanding our services in Latin America. Brazil and Argentina are large markets with great potential. We are the largest e-commerce player in these countries but have 30 percent or less of the market share.

CNBC: You've said that at this stage of the Internet, market share is more important than high margins. Why?

Galperin: We're just at the very early stages of the Internet (globally). E-commerce is in the low single-digit percentages of total retail. I look at the amazing brands that were built 100 years ago after the Industrial Revolution. Focusing just on short-term profits is not a way to ensure longevity. The way to ensure it is to get a lot of market share quickly.

For example, for the first seven years, we lost money on our marketplace business. It's now profitable. Online payments is going to be an area that is not extremely profitable in the next three years ... but it should be in 10 or 20 years. It's also going to be extremely competitive.

CNBC: What were the early days like?

Galperin: We founded the company in 1999, and then the first Internet bubble burst. Our growth rates were much lower than we said, but we had cut our burn rates, so we had money. So the investors said, "This is the one company that still has money. Let's shut them down and take the money out. The projections were that we were going to be profitable three years down the road.

We had to go to a shareholder vote (to stop the investors from shutting the company down).

CNBC: Is that a cautionary tale for taking venture capital?

Galperin: Yes.

CNBC: What about the challenges of starting a business in Latin America without a developed infrastructure?

Galperin: Government regulations vary, and some laws are challenging. If you go bankrupt in Latin America, you can go to jail if you don't have enough money to pay severance to employees for six months.

At the same time, adoption of the Internet is at a slower pace. When we started, the Internet penetration rate was 3 percent. Of those, only 10 percent did e-commerce. We knew it was going to get to 100 percent. We knew people would eventually access the Internet through different formats, and that is what happened. Today everyone has a mobile phone. Now e-commerce penetration is 50 percent of Internet users.

CNBC: How do you keep the company from becoming bloated? How do you keep innovating?

Galperin: We have a culture that it's better to cannibalize ourselves than to have someone else cannibalize us. Since 2010, we have been working on a deep technology overhaul that is allowing us to switch from a closed and monolithic system to an open and decoupled one.

We are splitting MercadoLibre into many small cells. We decentralized the software development so that each of the separate business units could operate independently and be responsible for their own success.

CNBC: You've talked about the power of e-commerce to transform the lives of people in South America. What do you mean by that?

Galperin: Retail is so inefficient here. It's a large geographic area with jungles. Unlike in the United States, where you go to any small town and you have a shopping mall, here, basically, you never had access to anything.

There were few large retail chains or shopping malls, so if a manufacturer wanted to distribute or a retailer wanted to distribute more goods, they had to set up physical locations in many places, which was difficult. Also, typically, you had two or three families that owned retail in each country. You had to go and negotiate with these gatekeepers to have your product carried in the retailers they controlled.

Basically, we connect buyers and sellers. We have basically democratized commerce. We have created a level playing field. We have 5.1 million retailers on our marketplace. And we estimate more than 145,000 people live from selling on MercadoLibre.

CNBC: What drives entrepreneurs?

Galperin: There are people that see the world the way it is and say, "I need to adapt myself." Others see something so wrong that they need to change it.

The latter is what needs to drive entrepreneurs. As long as that impulse to make the world [better] is a driving force, then I think you will have the energy to persevere.

If you fail, you will know, at least, that it was a worthy cause.

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