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1 Falabella: Challenges of a Latin American giant Jorge Tarzijan Pontificia Universidad Catolica de Chile, School of Management. I. Introduction By the end of 2012, Falabella was one of the main retailers in Latin America. Between 1998 and 2012, Falabella revenues increased by almost 15 times and EBITDA (earnings before interest, taxes, depreciation and amortization) increased by more than 20 times during the same period. (See Exhibits 1 and 2 for detailed revenue and EBITDA trends). In addition, the market capitalization of the company increased from approximately US$1.6 billion in 1996 (when the company went public) to approximately US$27 billion by April 2013. 1 At the end of 2012, the company, headquartered in Santiago, Chile, operated more than 296 stores in 4 countries. 2 The success of Falabella was more intriguing when considering that important international department stores (Muricy, JC Penney), home improvement chains (Home Depot) and supermarket chains (Carrefour and Disco Ahold) had entered the Chilean market but had exited after a short time. A striking feature of Falabella’s business model was the continuous expansion of its operations, at the horizontal, vertical and geographical level, despite the ongoing process of deregulation and trade openness undertaken by the country. After being started as a tailor, the company later became a department store. Horizontal scope was then expanded by entering into new businesses, such as supermarkets, home improvements and travel agencies. Vertical scope was increased by active participation in the shopping mall and financial sectors, while geographical scope was added mainly via international expansion to different South American countries. In between the company had also joined and exited other businesses, such as the drugstore business. As the development and growth of the company continued in the 21st century, Falabella was not short of important strategic challenges. Sandro Solari was appointed CEO by the end of 2012, replacing Juan Benavides, a long standing CEO who voluntarily resigned a few months earlier. Solari knew that the company faced important strategic challenges. One of the most important tasks was to decide whether or not to continue the company’s internationalization strategy and what variables should he look at when choosing international markets. Other examples of important challenges were related to the future organization of the credit card, shopping mall and supermarket businesses. Should Falabella maintain its successful credit business or externalize it partnering with a banking or specialized credit card institution considering the important recent development of the Chilean financial sector and the penetration of the more traditional credit cards (e.g. Visa and Master Card) to liberate resources to growth in its other businesses? Should Falabella continue its growth in the shopping mall business or should it focus on department stores, home improvement, and/or supermarkets? Behind each of those issues were two major related questions: Did the future lie with integrated retail groups or with more focused companies, a successful model that Falabella was not following? What challenges would entering new countries pose for implementing the company’s business
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Falabella: Challenges of a Latin American giant Jorge Tarzijan Pontificia Universidad Catolica de Chile, School of Management. I. Introduction By the end of 2012, Falabella was one of the main retailers in Latin America. Between 1998 and 2012, Falabella revenues increased by almost 15 times and EBITDA (earnings before interest, taxes, depreciation and amortization) increased by more than 20 times during the same period. (See Exhibits 1 and 2 for detailed revenue and EBITDA trends). In addition, the market capitalization of the company increased from approximately US$1.6 billion in 1996 (when the company went public) to approximately US$27 billion by April 2013.1 At the end of 2012, the company, headquartered in Santiago, Chile, operated more than 296 stores in 4 countries.2 The success of Falabella was more intriguing when considering that important international department stores (Muricy, JC Penney), home improvement chains (Home Depot) and supermarket chains (Carrefour and Disco Ahold) had entered the Chilean market but had exited after a short time.

A striking feature of Falabella’s business model was the continuous expansion of its operations, at the horizontal, vertical and geographical level, despite the ongoing process of deregulation and trade openness undertaken by the country. After being started as a tailor, the company later became a department store. Horizontal scope was then expanded by entering into new businesses, such as supermarkets, home improvements and travel agencies. Vertical scope was increased by active participation in the shopping mall and financial sectors, while geographical scope was added mainly via international expansion to different South American countries. In between the company had also joined and exited other businesses, such as the drugstore business. As the development and growth of the company continued in the 21st century, Falabella was not short of important strategic challenges. Sandro Solari was appointed CEO by the end of 2012, replacing Juan Benavides, a long standing CEO who voluntarily resigned a few months earlier. Solari knew that the company faced important strategic challenges. One of the most important tasks was to decide whether or not to continue the company’s internationalization strategy and what variables should he look at when choosing international markets. Other examples of important challenges were related to the future organization of the credit card, shopping mall and supermarket businesses. Should Falabella maintain its successful credit business or externalize it partnering with a banking or specialized credit card institution considering the important recent development of the Chilean financial sector and the penetration of the more traditional credit cards (e.g. Visa and Master Card) to liberate resources to growth in its other businesses? Should Falabella continue its growth in the shopping mall business or should it focus on department stores, home improvement, and/or supermarkets? Behind each of those issues were two major related questions: Did the future lie with integrated retail groups or with more focused companies, a successful model that Falabella was not following? What challenges would entering new countries pose for implementing the company’s business

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model?

II. History of Falabella3 Falabella was founded in 1889 when Salvatore Falabella, an Italian immigrant, opened the first large tailor shop in Chile. In 1958, Falabella evolved into a department store through the introduction of a wide array of home products. Falabella introduced its own credit card, CMR, in 1980. At that time, CMR was for exclusive use at Falabella’s stores. Falabella began an important expansion plan in the 1990s, which involved acquiring new businesses, entering new industries, and expanding its existing operations, both domestically and internationally. As part of this plan, in 1990 the company entered the shopping mall business when it acquired a 50 percent stake of the Mall Plaza group and opened Mall Plaza Vespucio, the first of several shopping centers opened in Chile targeted mainly at middle-income consumers. The internationalization of Falabella began in 1993, when the company opened a store in Mendoza, Argentina. Subsequently, stores in the Argentine cities of Cordoba, Rosario, and San Juan opened, as well. In 1995, Falabella entered Peru by acquiring 70 percent of Saga, the nation's main department store chain. In 1996, Falabella became a publicly traded company and began expanding existing businesses and entering into new sectors. At that time, the market value of the equity of the company was approximately US$1.6 billion. By the end of 1996, Falabella annual sales exceeded US$400 million; it had 22 stores in Chile, 2 in Peru, 2 in Argentina and more than one million names in its customer database, more than any other Chilean retailer. The database was formed with information collected from CMR’s cardholders, where each transaction made with the credit card was registered in a master database. The following year it entered the home improvement sector when it established a partnership with Home Depot taking a one-third share in its commercial ventures in Chile. That year the company also added a travel agency and an insurance agency to its businesses. In 1998, the first two Chilean Home Depot stores opened and a bank, BancoFalabella, was established. The bank is a separate entity; its operations are managed independently from Falabella’s core businesses, including CMR. In 2001, the company had 32 stores in Chile, 5 in Argentina, and 7 in Peru. Also, that year Falabella bought Home Depot for US$54.4 million, renamed it HomeStore and opened 2 new locations. Under Falabella’s management, the chain experienced 11% growth in sales and reversed three years of losses it had suffered under Home Depot name and management. Falabella’s expansion and growth continued strong. Though 2001 was a difficult year for many businesses, Falabella excelled and was voted company of the year by the business magazine Capital. It maintained its position as the largest department store chain in the nation, with 43 percent of the market and an intense growth’s plan.

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HomeStore was regarded as the vehicle the company was missing to continue growing in retail sales. The company made plans to invest about US$70 million each year for the construction of new outlets. Despite the chain’s success, with only 5 HomeStore locations open, it made up a small share of the US$4 billion-a-year home improvement market which was dominated by Sodimac S.A., with 51 stores in Chile (and six in Colombia). In 2003, after extended negotiation, Falabella merged with Sodimac by issuing to its owners new shares of its stock. This consolidated Falabella’s home improvement operations increasing its home improvement stores from 7 to 54 and increased its international presence, since Sodimac had 7 stores in Colombia. By that time, Falabella recorded net sales of US$2.16 billion and net income of US$196 million. In 2004, Falabella entered the supermarket business in Chile (it already was in the supermarket business in Peru) when it acquired for US$62.5 million an 88% share of the supermarket chain San Francisco. In 2006, continuing with its internationalization process, Falabella opened its first department store in Colombia. By that time the company had about 4.29 million CMR accounts, revenues of about US$4.37 million and net income of US$372 million. Continuing with its expansion plans, in 2008, Falabella entered Argentina by opening 4 Sodimac stores and doubled the size of department store operations in Colombia. In 2010, Banco Falabella started operations in Peru and in 2012 Mall Plaza started operations in Colombia. Through its subsidiaries and affiliates, by the end of 2012 the company operated 296 stores in Chile, Peru, Argentina and Colombia and its operation in different countries encompassed multiple businesses, which included its department stores, home improvement stores, supermarkets, CMR, and shopping centers. III. Falabella’s Business Units Department Stores In 1958, Falabella emerged as a department store in Chile. Fueled by growth and acquisitions, by the end of 2012, Falabella operated 86 department stores in four countries. As a department store, Falabella’s business strategy was characterized by offering a wide variety of products, which had been increasing over time. As part of its business model, Falabella sought to establish strong relationships with its suppliers, both domestically and abroad, seeking to offer a wide variety of products. The company had also developed and introduced an increasing selection of its own brand name products. Over time Falabella remained as the largest department store in Chile. In 2012, sales of its department stores in Chile reached US$2.277 billion and contributed to approximately 18.5% of the annual revenues of the company.4 (See Exhibit 3, which shows a breakdown of revenue by country). Falabella also operated department stores in Argentina, Peru, and Colombia. The company entered the department store business in Argentina in 1993 where by 2012 it operated 11 stores and had sales of US$589 million. In Peru, Falabella opened its first department store in 1995 and operated under the SagaFalabella brand name. By 2012,

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the company operated 19 department stores in that country and had revenues of US$930 million. In 2006, Falabella opened its first department store in Colombia; by 2012 it operated 14 stores and had revenues of US$594 million.5 In Chile, department store sales were able to grow together with the expansion of other business units, first, through the introduction of CMR, the company credit card, and subsequently through the development of other business units (i.e., shopping malls). Through CMR, Falabella extended credit to qualifying customers and rewarded customer loyalty. The company promoted customer loyalty by increasing its customers CMR credit lines, as well as through loyalty programs through which customers could earn and redeem points by shopping at Falabella’s department stores and other businesses. More than 60% of department store sales were paid with CMR, which was offered to qualifying customers at any Falabella location. Though the company operated standalone stores and stores in third-party shopping centers, Falabella’s department stores sales were positively impacted as its shopping mall business expanded. As it did in the Chilean market, Falabella’s international department stores also offered CRM, usually operated within shopping malls, and maintained products and services similar to those offered at the original locations in Chile. Although the company sought to consider local needs and consumer trends it generally maintained uniform store planning and general marketing and commercial policies standard. Operations abroad were strong and provided the company with diversified sources of income. Home Improvement In 1997, Falabella announced a joint venture with Home Depot in Chile. The first two stores under this business deal opened in 1998. In 2001, the company purchased 100% of Home Depot Chile and renamed the business HomeStore. As HomeStore, Falabella was able to immediately reverse losses that had occurred while operating under Home Depot’s brand name and management. Falabella’s home improvement division significantly expanded in 2003 when Falabella merged with Sodimac, a company that operated a large chain of home improvement stores under two divisions (home products and construction goods). Through this merge Falabella’s operations abroad expanded since Sodimac operated stores in Colombia. In 2012, the company had 80 home improvement stores in Chile with revenues of US$2.9 billion. Though Chile remained its strongest market, its international presence was significant. By 2012, Falaballa’s sales from Colombia, Peru, and Argentina made up more than 40% of the company’s total home improvement sales. In Colombia, the company operated 29 stores and was a market leader with sales of US$1.29 billion and strong growth perspectives. Likewise, its operations in Peru and Argentina had also continued to grow. In Peru, the company operated 18 stores and had sales of US$403 million. In Argentina, which Falabella had entered in 2008, it had, by 2012, 7 stores and its sales were US$185 million6.

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Similarly to department stores, sales at Falabella’s home improvement stores both domestically and internationally were driven by credit purchases using CMR (although in a smaller percentage than department store sales). Also, Falabella’s home improvement stores satisfied a wide range of customers needs since it offered both home products (such as furniture and appliances) as well as construction goods. In addition, home improvement stores maintained similar store planning, as well as benefiting from the company’s brand image and its store’s locations. Its home improvement stores were typically located within its shopping malls or other third-party shopping centers. Supermarkets Falabella entered the supermarket business in 2002 when it launched a supermarket chain in Peru under the brand name Tottus. After opening several more stores in Peru, it entered the Chilean market when it acquired San Francisco, a supermarket chain that had a small market share in the supermarket business (less than 4%). In 2005, Falabella opened the first store in Chile under the Tottus brand. The company operated supermarkets in Chile as both San Francisco and Tottus. Despite customers’ average purchase per visit to a supermarket being lower than average purchases per visit to a department or home improvement store, customers visit supermarkets more regularly. In addition, CMR was an important mean of payment in the company’s supermarkets. In May 2007, Falabella announced the intent to merge with D&S, the largest supermarket chain in Chile to strengthen and consolidate its market share in the supermarket industry, as it had done in the home improvement industry with Sodimac.7 At the end of 2006, the market share of D&S in the supermarket industry was about 33.5% and the share of San Francisco/Tottus about 5%. Their closest competitor would have been become Cencosud, which had a 31.3% of market share in the supermarket industry. Though D&S’s main line of business was by far the supermarket industry, D&S also had a relatively important participation in the credit card industry (through the company’s credit card, “Presto”) and a stake in the shopping mall business, as well. (See Competitors section, which talks about D&S’s industry presence.) The companies were seeking that their market shares, efficiency, and knowledge in their primary industries would have resulted in a facilitated pursuit of cost synergies and new economies of scale, as well as to have further favored the internationalization process of both companies. However, Chile’s antitrust commission (Tribunal de Defensa de la Libre Competencia) blocked the merge. They stated, “Carrying out this merger would lead to enormous change in the structure of the market, creating an enterprise that would be the dominant player in integrated retailing as well as in practically all of its individual segments (department stores, home improvement, supermarkets, real estate and associated financial businesses)”. Thus, Falabella, despite having shown growth and an increase presence in the supermarket industry, remained a relatively small player in that market. By the end of 2012, the company had 43 supermarket locations in Chile and 33 in Peru with revenues of US$996 million and US$665 million, respectively.

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Shopping Malls Falabella entered the shopping mall business in 1990 with a 50% participation in Mall Plaza. The shopping mall industry as a whole had been growing in previous decades. One of the main reasons behind this growth was the increasing preference shown by consumers to purchase different goods and services at the same place (“one stop shopping”) (see exhibit 4). To be successful, shopping malls must have a good variety and mix of offerings and important anchor stores—mainly department stores, home improvements and, to lesser extent, supermarkets.8 Falabella’s shopping malls offered attractions such as health centers, office space, gyms, and movie theaters. Its shopping malls typically included Falabella’s own department stores, home improvement stores and lately, Tottus supermarkets. Over the years, the company’s shopping malls had demonstrated favorable results, both in sales and visits. In 2012, the company operated shopping malls in Chile, Peru and Colombia. It had 19 shopping malls in Chile, 11 in Peru and 1 in Colombia. Its shopping mall operations in Chile and Peru were maturing and continued to attract customers. In 2012, more than 245 million customers visited Falabella’s shopping malls in the region, compared to 180 million in 20099. Credit & Financing Falabella was a key player in the credit card business through CMR, which was launched in 1980 as Falabella’s own credit card for exclusive use at its stores. It remained present in all areas of Falabella’s retail business. The success of CMR allowed Falabella to become an important player in the financial business. CMR provided the company with revenue resulting directly from financing customer credit. Indirectly it also contributed to sales since it provided customers the possibility of increasing their current purchasing power at any of Falabella’s businesses. Initially the use of the credit card was restricted to Falabella’s businesses, however the company gradually established alliances to improve CMR’s coverage. CMR coverage was extended as the company opened new businesses or expanded to new countries. Wherever a new Falabella business opened (department, home improvement, supermarket, travel agency or insurance business) CMR was introduced and offered to customers. Other services and benefits were also added to the card. For example, cardholders were later allowed the capability of withdrawing cash from store-owned ATMs, restricted use in other commerce, and earning points through a loyalty rewards program. To start a relationship with a client without a financial history, Falabella offered clients a credit card with a “small” credit line, which was dynamically modified according to consumers’ behavior. CMR’s cardholders were distributed among different income brackets, although the majority were people with mid levels of income (“low-mid”, “mid” and “high-mid” incomes). Though the majority of these people had become eligible for

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credit in the previous decade or so, due to both an increase in their average incomes and more lenient bank requirements, many of them continued to use CMR. Credit card use also allowed Falabella to obtain information from customers’ behavior in various businesses. This information was valuable to assess the credit lines offered to different consumers and to personalize special offers. The information attained was also useful for several other reasons (e.g., to determine the optimal location of stores in a shopping mall, to assess the worthiness of introducing new products, to implement loyalty programs). The information obtained by Falabella increased as the use of the credit card increased. Despite competition from many well-established commercial banks, main international card issuers (e.g. Visa and Master Card) and other store-owned credit cards, CMR had the largest base of users in Chile (see exhibits 5 and 6). In addition, CMR was present in over 60% of the company’s sales across its different market segments.10 Other Businesses Apart from its major lines of business, the company also operated other smaller business divisions. In 1997, the company introduced travel and insurance services. Its travel agency operated as ViajesFalabella and in 2012 served more than 350,000 travelers. Its insurance division operated as Falabella Pro. In addition, the company started BancoFalabella in 1998, which had bank operations in both Chile and Peru. However, the bank’s finances remained a separate entity from the rest of the company. The company also engaged in online retail and other commercial services. In 1999, Falabella had entered into the drugstore business when it acquired a 20% holding of Farmacias Ahumada (FASA). FASA was the leading drugstore chain in Chile (with an approximate 34% market share) and had outlets in Peru. The alliance allowed CMR credit card holders the ability to make purchases in FASA's national and international outlets using that credit card. However, in 2010, Falabella accepted an offer from the Mexican Grupo Casa Saba to acquire its stake in FASA. This was part of a major purchase by the Mexican group, which totaled 97.8% of FASA’s shares. When Falabella sold its stake in FASA, the approximate market share of the drugstore chain in the Chilean market was 30%, the second largest behind Farmacias Cruz Verde.

IV. Falabella’s Strategy

Falabella explained part of its strategy in its annual report: "We have been able to build a corporate structure that has allowed us to transfer the best practices and efficiencies and to take advantage of synergies among the different businesses and countries in which we operate, adapting our value proposition to each market and to each culture.”11 The company also mentioned, “Our goal is to continue developing our strategic plan under which we will grow significantly in all our formats in the countries where we are

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doing business. This does not preclude the possibility of entering new markets at the right time.”12 Juan Benavides, Falabella’s General Manager until 201213, explained that Falabella had been working intensely throughout the years to attain significant synergies between all integrated retail enterprises and had planned how to achieve others. “We will offer a good part of this integrated retail in all countries where we do business, depending on the needs of each location,” added Juan Guillermo Espinoza, corporate manager of planning and development of Falabella.14 The investment plan budget from 2013 to 2017 involved US$3.9 billion with 231 new stores and at least 20 new shopping malls in the region15. To finance its expansion plans Falabella had aimed to use a mix of cash flow and debt. Foreign expansion had been one of the strategies that Chile’s department stores had been employing to attain growth. Historically, there had been few specialty retailers or discount stores in the country making department stores the primary destination for clothing, furnishings and electronics. Since competition from hypermarkets and supermarkets had been growing, department stores had to find new ways to compete and increase efficiency. Hypermarkets were putting much effort into selling nonfood items, particularly electronics, appliances and family fashion16. Falabella internal organizational structure included a CEO per each business unit in each country, who was responsible for the local development of the business and providing feedback to the Corporate Manager on how growth was progressing. Each country also had a Country Manager to handle maximizing operating efficiencies between business areas and to ensure the implementation of projects. In addition, the company had managers in support areas such as finance, development, and technology and systems. “Because of our size, intermediate instances are needed in the countries where we are located to make synergies and the business model travel better and speed up the expansion,” said Juan Benavides. When Falabella introduced CMR in 1980, middle class consumers had had few credit options. The introduction of the credit card was very successful for the company and prompted the other chains to introduce their own retails cards, as well. Whereas Chilean commercial banks were mainly seeking low-risk customers, the department stores were willing to take the risk of host a wider client case. International department stores (e.g. Muricy, JC Penney), home improvement chains (e.g. Home Depot) and supermarket chains (e.g. Carrefour and Disco Ahold) had entered the Chilean retail market in previous decades with business models centered on their main businesses. However, after a short time in the market they had exited mainly because they were unable to compete with well establish local companies such as Falabella. An example of an unsuccessful entry into the Chilean market was Home Depot. Some observers mentioned that Home Depot lacked legitimacy in Chile because they failed to offer the range of merchandise and store atmosphere demanded by the traditional family shopping activity, and because their management team did not embed themselves in the

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broader social network.17 Similar reasons had been argued for the failures of JC Penney, Royal Ahold, Carrefour and Home Depot in the Chilean market18. The last big international player that entered the Chilean retail market was Wal-Mart in 2009. Wal-Mart acquired a controlling interest in D&S, Chile’s largest supermarket chain, completing its biggest acquisition in Latin America. (The D&S purchase was twice the size of Wal-Mart’s 1997 acquisition of Mexico’s Cifra SA for $1.2 billion; a Mexican joint venture that in 1991 was Wal-Mart’s first expansion outside the US.) The world’s biggest retailer offered 40.8 cents per common share in December 20, 2008, valuing D&S at about $2.66 billion, a premium of 37 percent over the average close price for the period included in the 30 days that preceded the acceptance of the offer. Wal-Mart acquired more than 180 D&S stores, 10 shopping centers and 85 financial-services offices. Craig Herkert, Wal-Mart’s Executive Vice President, commented on the acquisition, “We see an opportunity to grow in Chile as part of our strategy of being a significant retailer in all major markets of the Americas.”19 Falabella’s business model was not exempt of risks. Due to the relevance of its financial business and important amounts of lending, mainly funded with own resources, a sharp increase in interest rates would have put the company at risk since that would have increased the cost of internal funding. A significant increase in interest rates could have also affected the company given that consumption levels tend to decrease in periods of high interest rates.

V. Institutional Environment

The Republic of Chile spanned 756,950 square kilometers (292,183 square miles) and bordered the South Pacific Ocean to the West, Argentina and Bolivia to the East, and Peru to the North. The country had a population of around 16.5 million people with an approximate US$18,400 GDP (gross domestic product) per person.20 According to the per capita GDP, the country ranked 72th in the world and 1st in South America. Argentina’s GDP per capita was US$18,200, Brazil’s was US$12,000, Colombia’s was US$10,700 and Peru’s was US$10,700.21

Chile had been opening its economy to international trade and had deregulated its markets. On January 1, 2004, Chile and the U.S. became free trade partners. It had also signed a free trade pact with the European Union in 2002. Other important free trade agreements signed by the country have been with China (2005), Australia (2008) and Malaysia (2010). As a result of its openness to international trade, exports and imports had strongly increased. In the Global Competitiveness Report for 2012-2013, Chile was ranked as the 33th most competitive country in the world and the first in Latin America, above Brazil (48th), Mexico (53th), Peru (61th) and Argentina (94th).22 Chile's welcoming attitude toward foreign direct investment is codified in the country's Foreign Investment Law, which gives foreign investors the same treatment as Chileans. Foreign investors are guaranteed access to the official foreign exchange market to repatriate their profits and capital. In 2009 the Organization for Economic Cooperation and Development (OECD) invited Chile to

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accede as its 31st member, making it the second country in Latin America (after Mexico) to do so. As of November 2010, Chile maintained one of the best credit ratings (S&P A+) in Latin America. In spite of this, Chile also faced problems that are common to many Latin American countries, such as income inequality and a rather high unemployment rates. In the early 1980s, the Chilean economy went through a very serious financial crisis. This leads to an amendment to the General Banking Law and new regulations to include stern provisions for the safeguard of the stability and solvency of the Chilean banking sector. As a result, the financial crisis of 2008 brought no significant consequences on the Chilean banking industry. Partially because of tight regulations, the Chilean banking sector was, and had been for a while, a relatively concentrated one. The number of banks decreased from 36 in 1990 to 26 in 2012, and the combined market share of the four largest banks (C4) went up from 49% to 67% of the system loans23. In the previous 10 years, Chileans had enjoyed the introduction of new financial tools such as home equity loans, currency futures and options, factoring, leasing, and debit cards. The introduction of these new products was also accompanied by an increased use of traditional instruments such as loans and credit cards. Historically, bankarization in Latin America had been lower than in the USA and than in many European countries. However, bankarization levels had been steadily increasing in the last couple of decades, mainly because of the higher income levels, improving technology, better scoring systems and the growing interest of banks by market share. Alongside with the higher levels of bankarization, there was an increase in the total number of active credit cards issued by banks. However, the increasing number of banks’ credit cards had not been as impressive as the increase in the number of store owned credit cards.

Although there are similarities in the regulations for credit cards issued by banks and by commercial stores, there are also some differences. One of those differences is that the information regarding debt levels and customers’ behavior is proprietary in the case of store issued credit cards, (i.e. the store didn’t have to share that information with banks, other stores, government or another party) unless the cardholder did not fulfill her credit obligation, in which case the issuer of the credit card had to send the information regarding the defaulted client to a centralized database. On the contrary, the regulation applicable to banks’ credit cards obliged them to release the credit information of all their borrowers to a centralized database that could be accessed by banks and commercial stores. Another difference in regulation was related to the maximum collection charges allowed to cardholders who did not pay their debts on time, which were more constrained to banks than to commercial stores.

Exhibit 7 shows the proportion of consumers with credit cards issued by commercial stores and by commercial banks by socioeconomic group, where the ABC1 group is the highest income group and the D group is the lowest income group of those showed in that exhibit. Usually, department stores are open to customers seven days per week. Banks in Chile were usually open to customers Monday through Friday from 9am to 2pm.

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VI. Falabella’s Main Competitors Falabella faced competition domestically and internationally from large competitors on the integrated retail level (i.e. Cencosud) as well as from smaller competitors within each of its business units. Department Stores Falabella dominated the Chilean department store business. Its market share, when taking into account only its top competitors, was 37% in 2012. Falabella’s main competitors were Paris (Cencosud), Ripley and La Polar with market shares of 24.7%, 22.7% and 11.2% respectively (others explained 4.4%).24 Paris was owned and managed by Cencosud, an integrated conglomerate similar to Falabella, which was also one of the largest retailers in Chile and Latin America, with operations in Argentina, Brazil, Chile, and Peru. In 2012, there were 74 department stores operated by Cencosud (mainly with the “Paris” brand), which specialized in selling and financing a wide range of products including clothing, home products, and electronics. Paris offered exclusive product lines that were sold at its stores and at standalone locations, as well as both brand name products and products under its own brand name. Sales through its company credit card accounted for approximately 55% of its revenue.25 Ripley was a multinational retailer based in Chile with 40 stores in the country and 20 in Peru.26 Its main line of business was the sales and financing of products such as clothing apparel, accessories, furniture, and home products. Similar to both Falabella and Cencosud, Ripley’s sales were typically accompanied by financing through the company’s own credit card. Besides department stores, Ripley was also engaged in banking, insurance, and real estate. Retail chain La Polar also competed with Falabella on the retail level. It operated 40 stores, had its own company credit card, and had begun to move abroad after entering Colombia in 2009. Falabella also faced some competition from multipurpose stores (i.e., Hites, Tricot, Corona and Johnson’s), hypermarkets and stores specialized in specific product lines (electronics, clothing, sport goods, etc). As such, the market share of the main department stores is smaller if we take into account these smaller stores and individual product lines as part of the relevant markets. In Peru, Falabella’s main competitor was Ripley, which operated 20 stores, compared to Falabella’s 19 stores. Home Improvement Falabella dominated the Chilean home improvement market. Falabella operated home improvement stores that offered both home products, such as furniture and appliances, as well as construction goods. Falabella’s top competitor (among stores that offered both

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home and construction products) was Easy. Easy was Cencosud’s home improvement division and operated 31 stores in Chile (compared to Falabella’s 80). Cencosud was the largest operator of home improvement stores in Argentina where it operated 47 stores Colombia (and 4 in Colombia). Falabella also faced competition from hardware stores such as MTS, Chilemart, and Construmart. In Peru, where Falabella operated 18 home improvement stores, its main competitor was Maestro, which had 12 stores and offered financing through its company card. Together they made up about 20% of the market share, the rest of the market was highly fragmented. In Colombia, Falabella operated 29 home improvement stores and competed with Easy, which had entered the market in 2008 and operated 4 stores (in Argentina, Falabella had 11 home improvement stores). Supermarkets In 2012, the Chilean supermarket industry was dominated by D&S/Walmart, Cencosud, and SMU.27 In 2009, Walmart purchased a majority stake of D&S and operated 250 stores in Chile holding a market share of 32.6%. At the end of 2011, Walmart has a 40.9% of market share in the supermarket industry. Cencosud maintained the second largest market share, primarily operated as Jumbo and Santa Isabel, with a market share of 28,7%. SMU was the result of a consolidation move, which brought together different supermarket chains. SMU held a market share of 24.1%. On the other hand, Falabella, operating under its brand names Tottus and San Francisco, held a 6.3% market share.28 In Peru, where the industry was estimated at US$6.5 billion a year, Falabella’s top competition came from Cencosud (where it operated under the Wong brand name) and Supermercados Peruanos. Cencosud operated 86 stores and was the largest player.29 Supermercados Peruanos operated more than stores, while Falabella operated 33. Cencosud bought the operations of the Dutch Royal Ahold in Chile in 2003 and in Argentina in 2004. D&S bought the Chilean operations of the French giant Carrefour in 2004.30 In November 2007, Cencosud acquired Barbosa, the largest supermarket chain in the northeast of Brazil.31 However, despite important acquisitions by different players, the opening of new stores had primarily driven industry growth. Shopping Malls Falabella competed in the shopping mall business with Cencosud, Parque Arauco, and SAITEC (D&S). Falabella had a majority stake in Plaza S.A., which operated shopping malls under the brand name Mall Plaza. In Chile, Falabella controlled and managed 12 shopping malls and 7 power centers, being the largest shopping mall operator in Chile. Plaza operated 6 of its malls in the capital, Santiago. All of its malls operated as a chain under the Mall Plaza brand, which created marketing, operational, and commercial synergies. In addition, Plaza also operated in Peru, as Mall Aventura Plaza and managed four malls.32

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Cencosud owned and operated 25 shopping centers of which 9 were in Chile, 14 in Argentina, and 2 in Peru. In 2012, it was the second largest mall operator in Chile and the largest operator in Argentina33. Parque Arauco S.A. operated shopping malls in Chile, Peru and Colombia. In Chile, it operated 8 shopping malls, in Peru operated 4 and in Colombia it operated 1 shopping mall. malls with a surface area of 286,286 squared meters.34 The ownership of Arauco is not related to the ownership of any anchor store. SAITEC S.A. was D&S’s real estate division, which was in charge of buying, building and developing D&S stores and shopping malls. Its shopping centers ranged in size, some contained several anchor stores and only several other shops, while others were more extensive projects, which housed supermarkets, movie theaters, food courts, etc.35 Credit & Financing As part of its financial retail division, Falaballa operated its CMR credit card and faced competition from other retail as well as banking institutions and international operators (i.e., Visa, Mastercard). All of Falabella’s leading retail competitors offered financing and earned additional revenue from credit card sales, however, Falabella remained as the industry leader in the credit card business. In 2012, Falabella had approximately 6.0 million active credit cards. Its top competitor was Cencosud’s Tarjeta Mas with 2.4 million cards. Ripley and D&S also issued their own company cards, and had 2.4 million and 1.6 million cards respectively.36 Cencosud offered its customers its credit card Tarjeta Mas. Similar to competitors’ cards, it was accepted at all of Cencosud’s retail locations. As was typical with most of the retail credit cards, Cencosud offered its cardholders perks such as exclusive offers at its stores and the chance to earn double rewards points at certain locations. Ripley offered its customers a retail credit card, accepted at all Ripley locations and in over 20,000 affiliated businesses. Cardholders were also able to take advantage of exclusive promotional offers in the company’s and its affiliates stores. The company listed several other benefits of it card, such as cash withdrawals of up to 100% of credit line, minimal application requirements, and a reward program that allowed customers to accumulate and redeem points for use at any Ripley location37. D&S offered its customers credit through its card “Presto” and followed a very similar framework to its competitors. (I.e, ease of use, exclusive offers, rewards programs, etc.) At Paris, approximately 70 percent of sales volume was conducted by means of its credit card; the rest was divided equally between bank-issued cards and cash transactions.38 Ripley’s in-house credit card accounted for approximately 63 percent of sales, and Falabella’s card carried approximately 67.2 percent of sales. Besides generating profits, in-house cards rendered other benefits, such a encouraging consumption through loyalty programs and providing the means of building a database of clients.39

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In addition, CMR faced competition from several other credit cards managed by banks and stores, debit cards, consumer loans offered by banks, equalization funds, and savings associations. CMR also operated abroad and competed with retailers and banks in other countries. Other Industries Falabella’s insurance division competed against many independent insurance brokers as well insurance brokers that formed a part of other stores, such as Seguros Presto (D&S), Seguros Paris (Cencosud), and Seguros Ripley. Similarly, in the travel agency business, Falabella faced competition from independent travel agencies and from travel divisions of other companies, such Travel Club (related to Banco Chile, the main financial institution in the country) and Cencosud’s Viajes Paris VII. Conclusions With the rapid development of the retail sector in Latin America, Falabella’s management had much to consider related to the development reached by the company so far, as well as future strategic moves. Their next decisions were especially important because of the dynamics of the retail market, including the arrival of Wal-Mart to Chile, and the constant moves of their main competitors, such as the participation of Cencosud in the giant Brazilian market. Among the main issues that had to be resolved were whether or not the company should continue with its current array of businesses or if it should try to go further into more retail activities or, alternatively, de-integrate some of them to specialized in only a few of them. Management was also considering how the possible continuing trend towards deregulation and openness to the international market would affect the “optimal” corporate strategy of the company. An issue that was always discussed was related to the complementarity among the different businesses, mainly: Does Falabella compete in the "integrated retail" business or does it compete in a number of separated markets?

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Exhibit 1 Evolution of Revenues (in millions of US$)

Source: Falabella Annual reports (accesed from Falabella.com).

851 1.514

1.921

3.511

4.706

6.583 6.532

10.718

12.309

1998 2000 2002 2004 2006 2008 2009 2011 2012

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Exhibit 2 Evolution of EBITDA (in millions of US$)

Source: Falabella Annual reports (accesed from Falabella.com).

73

186

282

425

548

758

861

1.622 1.590

-

200

400

600

800

1.000

1.200

1.400

1.600

1.800

1998 2000 2002 2004 2006 2008 2009 2011 2012

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Exhibit 3 Breakdown of Revenues by country

Source: Falabella, Corporate Presentation. Pactual, 2013 (accessed from www.falabella.cl).

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Exhibit 4 Number of Annual Visits to Falabella’s Shopping Malls

Source: Falabella, Presentation 2010 and other public sources.

1996

1998

2000

2002

2004

2006

2008

2010

2012

70 75 91 106 114 128 147 164 185 199 206

Visits to Falabella's shopping malls

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Exhibit 5 Number of Credit Cards Issued by Retailers (stock a Diciembre del 2009)

Issuer Active Cards

Falabella 6,011,811

Ripley 2,500,759

Cencosud 2,398,406

La Polar 1,660,465

D&S 1,524,090

Others 2,253,395

Total 16,348,926

Source: SBIF. Informe trimestral de tarjetas de crédito. 2010.

Exhibit 6 Number of Credit Cards Issued by Banks (stock a Diciembre del 2009)

Issuer Active Cards

BANCO BICE 26,976

BANCO BILBAO (BBVA) 118,920

BANCO DE CHILE 1,019,235 BANCO DE CREDITO E INVERSIONES 483,526

BANCO DEL ESTADO DE CHILE 431,416

BANCO FALABELLA 78,124

BANCO ITAU CHILE 84,357

BANCO RIPLEY 45,567

BANCO SANTANDER-CHILE 1,620,749

BANCO SECURITY 36,239

BANCO PARIS 15,859

COOPEUCH 33,005

CORPBANCA 190,616

SCOTIABANK SUD AMERICANO 159,124

BANCO INTERNACIONAL 11

HSBC BANK 3

Total 4,343,727

Source: SBIF. Informe trimestral de tarjetas de crédito. 2010.

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Exhibit 7 Credit Card Ownership by Socioeconomic Group

Socioeconomic group ABC1 C2 C3 D

Credit card only in bank 16% 13% 0% 1%

Credit card only in commercial store

25% 35% 60% 82%

Credit card in bank and in commercial store

59% 52% 40% 17%

Source: Brain Network. 2007.

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Footnotes

1 Information from Bloomberg.com as of April, 2012 (http://www.bloomberg.com/quote/FALAB:CI). 2 2012 Falabella Annual Report (from www.falabella.cl). 3Adapted from the Company’s Annual Reports and http://www.fundinguniverse.com/company-histories/SACI-Falabella-Company-History.html 4Falabella Corporate Presentation: III Latin Opportunities conference. Pactual, April, 2013 (from Falabella.cl). 5 Falabella Annual reports 2005-2012. 6Falabella Corporate Presentation: III Latin Opportunities conference. Pactual, April, 2013 (from Falabella.cl). 7 http://www.reuters.com/article/idUSN1742360020070517 8 http://www.mallplaza.cl/plazaSA/contenidos/inversionistas/inversionista.php 9 2012 Falabella’s Annual Report. 10Annual report, 2009

11 Translation from the 2009 annual report.

12 Falabella, annual report, 2008, Letter of the president to shareholders

13 Juan Benavides was Falabella’s general manager until 2012. He was then replaced by Sandro Solari. 14 Falabella Annual Report. 15 Falabella’s Corporate Presentation. Pactual 2013 (http://www.falabella.com/static/staticContent/content/minisitios/Inversionistas/images/contenidoDescargable/presentaciones/2013/PresentacionConfBTGLondres.pdf).

16 <http://www.icsc.org/srch/sct/sct0905/retail_chile.php>

17 Bianchi, Constanza and Arnold, Stephen J. (2004) An Institutional Perspective on Retail Internationalization Success: Home Depot in Chile. International Review of Retail, Distribution, and Consumer Research 14(2):pp. 149-169.

18 Constanza Bianchi and Enrique Ostale. Journal of Business Research. Volume 59, Issue 1, January 2006, Pages 140-147

19 Source: <http://www.bloomberg.com/apps/news?pid=newsarchive&refer=latin_america&sid=aRRZOpO3GvI>

20 “CIA World FactBook” accessed November 2013.

21 “CIA World FactBook” accessed November 2013.

22 Wikipedia. From original source: <http://www.weforum.org/pdf/GCR09/GCR20092010fullrankings.pdf>

23 Information obtained from a report issued by the “Superintendencia de Bancos e Instituciones Financieras” of Chile (www.sbif.cl/sbifweb3/internet/archivos/info_fin_602_12256).

24 Source: Celfin Capital, Falabella Company Update 9 April 2010

25 Cencosud, Roadshow presentation. 2012 (from www.cencosud.cl).

26 See, Ripley’s corporate presentation. Larrain Vial conference, 2013 (from www.ripley.cl). 27 Celfin capital

28 Source: America Retail.

29 cencosud.cl/unidades_wong_peru.htm

30http://www.carrefour.com/docroot/groupe/C4com/Pièces%20jointes/Communiqués%20financiers/Cession%20Chili%20281203GB.pdf

31 http://www.alacrastore.com/mergers-acquisitions/Cencosud_SA-3642045

32 http://www.mallplaza.cl/plazaSA/contenidos/inversionistas/inversionista.php

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33 Cencosud Roadshow presentation (2012). (http://www.cencosud.com/inversionistas).

34 Investor presentation. Parque Arauco, November, 2011. http://www.parauco.com/wp-content/uploads/2012/10/Investor-Presentation-Noviembre-2012.pdf

35 Conoce Nuestros Centros Comerciales. <http://www.saitec.cl/>

36 Sources : America Retail (http://america-retail.com/industria-y-mercado/falabella-concentra-el-40-de-las-tarjetas-de-credito-no-bancarias); Ripley corporate presentation (http://www.ripleychile.com/inversionistas/wp-content/uploads/2013/03/1303-Ripley-Ripley-Corp-LV.pdf); and Cencosud Roadshow presentation (http://www.cencosud.com/inversionistas/).

37 bancoripley.com.pe 38 Presenation Cencosud, “Marzo 2010” 39http://www.bancoripley.com.pe/web-banfinancor/tarjetas_credito/clasica_beneficios.jsp


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