C o n f e r e n c e o n F a s t M o v i n g C o n s u m e r G o o d s

Federation of Indian Chambers of Commerce and Industry

Knowledge Partner

July 23, 2009Federation House, Tansen Marg, New Delhi

Chapter 1: BackgroundResearch MethodologyA Special Note

Chapter 2: Size, Growth and Significance of the FMCG Sector in IndiaIndustry Size Growth ProjectionsSignificance & Contribution of FMCG Sector

Economic contributionFiscal contributionSocial contributionContribution to Other Sectors

Impact of the Current Economic Slowdown in IndiaTo Sum Up

Chapter 3: Growth Drivers, Challenges and Opportunities for FMCG SectorGrowth Drivers

Demand-side DriversSupply Side DriversSystemic Factors for Sectoral Growth

Favorable changes in Government Policies1. Infrastructure Development2.

ChallengesTax Structure1. Infrastructural Bottlenecks2. Counterfeit and Pass-offs3. Emergence of Private Labels4. Regulatory Constraints 5. Prices of Inputs6.

OpportunitiesLow Category Penetration at present1. Impact of Modern Retail on FMCG Sector2. Goods & Service Tax (GST) Implementation3. Zero Central Sales Tax (CST) 4.

To Sum up

Chapter 4: Recommendations to StakeholdersRecommendations for FMCG playersRecommendations for RetailersRecommendations for the Government

About TechnopakAbout FICCIAuthors

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Contents

1

The Indian economy is changing in profound ways by the onward march of its “consumers”.

Consumer growth has, of course, always been a central engine of economic growth, but what is significant about the past decade is the acceleration in the pace of change, which in one way reflects greatly on the growth, character and role of FMCG companies.

Having stated this, even the most prestigious FMCG firms are always under pressure when it comes to retaining position and growing in the ever competitive scenario. This is a big challenge, and it is rapidly becoming a strategic imperative.

In order to recognize the contribution of the FMCG sector to the socio-economic growth of India, to analyze opportunities and challenges over the coming years, and to develop recommendations to its stake holders (including FMCG companies, retailers and the Government), FICCI’s FMCG Committee and Technopak joined hands to produce this first of its kind research report on the FMCG sector.

This research report dwells into the current state and future outlook of FMCG industry, along with deliberating on issues, challenges and opportunities facing the FMCG industry.

The report suggests practical strategies and recommendations for policy makers towards achieving competitive advantage in an increasing competitive scenario.

Research Methodology

This report has been created through research and analysis over the last 12 months. We interviewed over 30 senior executives from FMCG companies, and various industry experts and stake holders. In addition to primary research, we have extensively utilized Technopak’s internal Body of Knowledge, various media reports, and other data sources. We provide recommendations to stake holders that we believe can fully unlock the potential of this sector in the coming years.

Chapter 1

Background

2

A Special Note

We commend the contributors to this Report for their energy and commitment in producing a valuable resource for policy makers. A special mention to:

In addition to the names above; a special mention and special thanks to Mr. Bharat Patel, Former Chairman, FICCI FMCG Committee and Mr. Shantanu Khosla, Managing Director, P&G Hygiene & Health Care Ltd and Chairman, FICCI FMCG Committee, without whose attention and contribution towards the subject the report would not have been possible.

Company Name Designation

Britannia India Ltd Durgesh Mehta Finance Head

Britannia India Ltd Rajesh Lal Head, Operations

Britannia India Ltd Alagu Balaraman HR Head

Cadbury India Ltd Anand Kripalu Managing Director

Dabur India Ltd Sunil Duggal Chief Executive Officer

Dabur India Ltd Rajan Verma Chief Financial Officer

Dabur India Ltd A Sukhakar Executive Director- HR

Godrej Consumer Products Ltd S. K. Bhatt Executive Vice President – Corporate Services

Godrej Consumer Products Ltd Sumit Mitra Executive Vice President-HR

Hindustan Unilever Limited Ashok Gupta Director Legal

Johnson & Johnson India Ltd Narendra Ambwani Managing Director

Johnson & Johnson India Ltd K.K. Mehta Vice President – Finance

Johnson & Johnson India Ltd Ananthram Kini Vice President – Operations

Johnson & Johnson India Ltd Manoj Gadgil National Customer Marketing Manager

Parle Agro Limited Krishnan. S. DGM – Taxation

Parle Agro Limited Parag Page Head – Human Resource

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Industry Size:

The Indian FMCG sector is estimated at US$ 25 billion1 (Rs. 120,000 crore), including tobacco. It has grown consistently over the last 3-4 years, including the last 12 months of economic slowdown. Unlike developed markets, which are dominated by a handful of large players, India’s FMCG sector is fragmented and a substantial part of the market comprises of unbranded and unpackaged products.

In the last 2-3 years, it has overcome a slow-growth slump to grow at between 12% - 15%, and is expected to grow at a CAGR of around 12% over the next few years to reach a size of US$ 43 billion (Rs. 206,000 crores) by 2013 and US$ 74 billion (Rs. 355,000 crores) by 2018. Exhibit I provides a product wise break-up of the sector.

It is a sector with a relatively less discretionary demand and therefore tends to be relatively stable in the long term, though consumers do up or down trade with economic fluctuations. At times of economic slowdown as at present, for instance, consumers may be cutting down on durable and other capital expenditure but cannot avoid spends on daily necessities and sometimes even be more willing to splurge in the form of little indulgences on the FMCG products. Having stated that, a large number of FMCG products, especially those for mid and mass markets, are price elastic (for a given price reduction, consumption increases by more than the percentage of price reduction).

Growth Projections

Most FMCG products (non-durables) are daily use products, and therefore, their volume consumption has been largely unaffected in the current economic slowdown. The sector has coped well with recent challenges and grew by 15% over the last year.

Significance & Contribution of FMCG Sector

The FMCG sector in India has played a vital role in the growth and development of the country, from making efforts to reach out to the poorer section of consumers through distribution of smaller pack sizes, innovations like single use sachets, to developing innovative products to cater to regional or local tastes and the needs of niche consumers. There are many significant contributions – both direct and indirect that the industry has on the Indian economy.

Chapter 2

Size, Growth and Significance of the FMCG Sector in India

1. Conversion Rate: US$ 1.0 = Rs 48.002. Technopak Analysis3. Technopak Analysis

Exhibit 12 : FMCG Industry Category Breakup

Food &Beverage53%

Personal Care20%

Tobacco15%

Household Care10%

Lighting2%

2003 2004 2005 2006 2007 20080

5

10

15

20

FMCG Sector Growth

Exhibit II3 : FMCG Sector Growth

2%4%

10%

15% 16% 15%

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Economic contribution

Employment

The FMCG sector is one of the larger employers in the country. The total salary outlay of the sector on direct employment is estimated at approximately 6% of turnover, i.e. US$ 1.5 billion4 (Rs. 7,000 crores).

There are approximately 12-13 million retail stores in India, out of which 9 million are FMCG kirana •stores. Thus the sector is responsible for the livelihood of almost 13 million people5.

Fiscal contributionCascading Multiple Taxes (Import duty, CENVAT, Service Tax, CST, State VAT, Octroi/Entry Tax and Income Tax) are paid at multiple points (levied at Centre, State, City and mandis) by the FMCG sector. On an average therefore, almost 30%6 (and much more for liquor and tobacco categories) of the revenue of the sector goes into both direct and indirect taxes. At an estimated size of $25 billion (Rs. 120,000 crores), that would constitute a contribution to the exchequer of approximately US$ 6.5 billion (Rs. 31,000 crores).

Social contributionIt is a sector which helps create employment for people with lower educational qualifications. Many become small entrepreneurs operating their own kirana store. Along with this, FMCG firms have also undertaken some specific projects to integrate with upcountry and rural areas for both inputs and for distribution as well as to fulfill CSR. Some examples:

ITC echoupal and Choupal Sagar – Choupal Sagar is ITC’s chain of rural retail which sells both agricultural •inputs and daily needs products. ITC’s rural e-network enables farmer connectivity and provides an easy way for farmers to get better profitability and control through access to timely information.

HUL’s Shakti Amma network – HUL pioneered a rural entrepreneurship model amongst women who •became HUL distributors and through this status also gained stature in their local community and now operate as entrepreneurs for other product categories than FMCG products.

Dabur India regularly conducts rural and adult education programs and provides training in rural areas •to facilitate employability.

Contribution to Other SectorsThe FMCG sector has a strong impact on several other sectors of the economy – agriculture; supply chain; ancillary industry; packaging; media.

Agriculture -1. Its intake of agricultural output as raw material is estimated to constitute roughly 9% of total turnover for the sector. That would put its total value to agriculture at US$ 2.2 billion7 (Rs. 10,500 crores).

Third Party Logistics -2. The third-party logistics market for the FMCG sector in India has been growing at a CAGR of ~12% since 2002, and is estimated to be worth US$ 63 million8 (Rs. 300 crores). It is anticipated to double by 2011, and be worth over US$ 146 million (Rs. 700 crores) by 2012, a growth of 211% from 2002. India’s infrastructure in both transportation and warehousing facilities has been lacking which enables the growth of independent third party logistics (3PL)-players to come up to bridge the gaps.

Ancillary Industries -3. Ancillary industries like manufacturing and distribution are greatly boosted by the FMCG sector.

Manufacturing – a. Almost 9-10% of total sector’s production is outsourced to contract manufacturing units taking the total size to $ 1.7 – 2 billion (Rs. 8,000 – Rs. 9,500 crores), approximately9.

Distribution – b.

ITC services 1.1 million outlets at an average frequency of three days down to villages with i. population of 2,000, and has 1,000 wholesale dealers.

Marico reaches 1.6 mln outlets, through almost 900 direct distributors, 100+ super distributors, ii. catering to almost 2,500 small stockists and 4,600 van markets.

4. Technopak analysis – Derived from salary payouts as % of turnover for listed companies, then extrapolated to industry size5. Mr. Shantanu Khosla, MD, P&G India6. Mr. Shantanu Khosla, MD, P&G India7. Technopak analysis – Derived from proportion of agricultural produce used as raw material by listed companies and projected for industry size8. Frost and Sullivan report9. Mr. A. Sudhakar, Dabur India

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HUL reaches 50,000 villages through 6,000 stockists, apart from 3.5 lac direct selling agents iii. and distributes products to a staggering 6.5 million retail outlets.

Packaging Industry - 4. The packaging industry for the FMCG sector alone is worth US$ 2.9 billion10 (Rs. 14,000 crores), and is expected to grow faster due to the growth of private label FMCG products through both modern and traditional retailers as well as the increasing shift from loose to packaged goods.

Media Industry - 5. The media industry has a lot to gain from the FMCG sector. Around 40% of media industry earnings from advertising (US$ 5 billion) are estimated to come from the FMCG sector, a contribution of US$ 2 billion (Rs. 9,500 crores)11.

Tourism Industry - 6. Penetration of familiar brands across the length and breadth of the country provides comfort and reassurance of quality to both Domestic and International tourists. The state of availability and quality of these brands in some ways help increase the flow of tourism in the country.

Impact of the Current Economic Slowdown in India

Our research finds that consumption expenditure of a household has declined more than decline 1. / slowdown in their income. This suggests a decline in the share of consumption in income and a greater weight given by consumers to the precautionary motive of saving. Also, Indian consumers have reduced their expenditure shares on Durables and Semi-durables, and have allocated these savings to consumption of Non-durable goods (which function as necessities).

The economic uncertainty has resulted in simultaneous movements of consumers to uptrade and 2. increase consumption, even as others cut back consumption or indeed downtrade.

In many parts of rural India, we found consumption increasing due to growing incomes led by rising •food price realizations and Government schemes like the National Rural Employment Guarantee Scheme (NREGS).

Simultaneously, we found some signs of downtrading in urban homes with fixed incomes given the •more direct impact that such consumers have experienced due to the downturn.

Most FMCG products (non-durables) are necessities, and therefore, their volume consumption has 3. been largely unaffected in the current economic slowdown. The sector has coped well with recent challenges and grew by 15% over the last year.

To Sum Up

The sector’s contribution to the economy at large is substantial. One of the largest employment sectors in the country, it directly contributes to the livelihood of almost 13 million people, and directly pays out an estimated US$1.5 billion (Rs. 7,000 crores) as salary costs. Its contribution to the tax exchequer is also large at US$ 6.5 billion (Rs. 31,000 crores). It also provides opportunities for employment and revenues to a host of other sectors, ranging from agriculture to ancillary industries, supply chain industry and media and entertainment. Its total contribution by way of employment salary, taxes and pay-outs to other sectors comes to an estimated US$ 17 billion (Rs. 82,000 crores). The sector also invests in Corporate Social Responsibility programs to help the development of under privileged communities.

10. Madras Consultancy Group, Chennai11. Mr. Shantanu Khosla, MD, P&G India

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Chapter 3

Growth Drivers, Challenges and Opportunities for FMCG Sector

Growth Drivers

The current economic trend, exhibiting modest demand and supply is likely to have a medium-term impact on the demand for FMCG products but promises revival and higher growth in the long term based on the following fundamentals:

Expanding purchase basket resulting in higher penetration of products1.

Increased consumption with higher disposable household family income 2.

More consumers entering the market place (Rural and urban base of pyramid)3.

For these developments to catalyse faster there are two sides of the equation that need to come together – demand and supply along with other systemic factors.

Each of the driver mentioned above are detailed in the following section.

Demand-side Drivers

Consistent GDP Growth1. The Indian economy has been consistently growing over the last few years. The growth rate in 2008-09 was lower (6.7%) compared to previous year.

Exhibit III: Growth DriversDemand-side Drivers

• Consistent GDP Growth• Increasing Consumer Income• High Private Consumption• Rising Urbanization• Increasing Discretionary Income

Systemic Drivers

• Favorable changes in Government Policies• Infrastructure Development

Supply-side Drivers

• Growth of Modern Retail• Newer product categories meeting consumer needs• Low Labour cost

Exhibit IV12 : GDP Growth %

0%

2%

4%

6%

8%

10%

12%

2001 2002 2003 2004 2005 2006 2007 2008

5.60% 6.00% 6.00%6.80% 6.50%

8.40%

9.70%

6.70%

12. Economic Survey 2008-2009

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Increasing Consumer Income2. Increase in incomes is largely an outcome of economic growth across sectors. Over the past few years, India has seen increased economic growth, with a continuing and substantial impact on consumer disposable incomes enabling good growth for the FMCG sector, among others

High Private Consumption3. The Indian economy, unlike most Asian economies, has a very high rate of private consumption (61%). Of that, a further 60% is due to retail spends – goods and products that people consumer, as opposed to services or essential consumption items like rent and education.

Rising Urbanization4. India has 70% of its population living in rural areas. With rising urbanization, more people will have exposure to modern products and brands and thus shift to branded and packaged goods and products.

By 2015, an additional 75 million consumers will have moved into cities, not only buying FMCG products for themselves but also serving as a conduit for information and goods to their families still in rural India.

FoodApparelBeveragesFootwearConsumer durablesAppliancesStationeryKitchen utensilsFurnitureFurnishingsSports goodsPersonal CareJewelleryTiming

HealthcareTransport CommunicationRecreationCultural Services EducationRent UtilitiesOther Services

Private ConsumptionUSD 708 bn (61%)

RetailUSD 411 bn (58%)

Non-RetailUSD 297 bn (42%)

Urban(5100 cities)USD 185 bn (45%)

Rural(6,27,000 villages)USD 226 bn (55%)

Public spending & GrossCapital Formation USD 453 bn (39%)

GDP USD 1,161 bn*

Exhibit V14: GDP Breakup

30%

70%

35%

65%70%

2007 2015

Urban

Exhibit VI15: Rising Urbanisation

Rural

0%

20%

40%

60%

80%

100%

13. NCAER14. Central Statistical Organisation (CSO) and Technopak Analysis, as on 31 March 200815. Technopak Analysis

Annual Household Income(‘000 INR p.a )

2001-02(‘000HH)

2005-06 (‘000HH)Growth

(05-06/ 01-2)2009-10

(‘000 HH)Growth

(09-10/ 05-6)

< 45 61351 52410 -15% 34623 -34%

45-90 70196 79225 13% 79678 1%

90 – 135 26159 33721 29% 49050 45%

13 – 180 12797 16251 27% 21307 31%

180 – 200 2258 3250 44% 4883 50%

200-1000 10727 16251 51% 28409 75%

1000+ 753 2235 197% 3995 79%

Table I13 : Annual Household Income

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Increasing Discretionary Spends5. Another encouraging factor is the falling spends on basic food items which frees up consumer income for other categories of FMCG products. This trend is noticeable among both urban and rural consumers.

Supply Side Drivers

Growth of Retail1. From US$ 410 billion in 2008 (Rs. 2,000,000 crores), Indian retail is expected to grow to US$ 535 billion by 2013 (Rs. 2,600,000 crores) and US$ 755 billion by 2018 (Rs. 3,600,000 crores).

Modern Retail - At current size of US$ 18 billion (Rs. 86,000 crores), modern retail is 5% of overall retail. However, with anticipated US$ 30 billion (Rs. 144,000 crores) in fresh investments over the next 5-7 years, modern retail will show impressive CAGR of more than 30%. (Exhibit VIII) Technopak projects it to grow to US$ 73 billion (Rs. 350,000 crores) by 2013 and US$ 170 billion (Rs. 816,000 crores) by 2018. From being apparel and lifestyle led, Modern Retail will be a greater reflection of the actual share of wallet of the average consumer. We believe this growth will be a key growth factor for the FMCG sector in India. For example:

Wal-Mart India is now planning to accelerate its expansion plans by opening up to 15 stores in •the country within three years, instead of seven as earlier planned

MORE (Aditya Birla Group) plans to roll out more stores but may wind up 10-20 existing outlets •as part of a clean-up operation

Reliance Retail Limited is planning to invest US$ 100 million(Rs. 500 crore) to add at least 92,000 •square meters of retail space in the fiscal year to March in India.

Traditional Retail – In absolute terms, Traditional Retail will grow more than Modern Retail, in the next 5 years. This is contrary to most projections on this topic. From current US$ 392 billion (Rs. 1,900,000 crores), we project Traditional Retail to add US$ 70 billion (Rs. 336,000 crores) and grow to US$ 462 billion (Rs. 2,200,000 crores). As per Technopak’s Retail Evolution Model (TREM), from current 9 million, the numbers of outlets selling FMCG is expected to increase to 11 million by 2013 and 16 million by 2018. In summary, Traditional Retail will grow slower in percentage terms, but will continue to occupy a very dominant share of FMCG sales over the next 10-20 years.

Savings & Investment

Discretionary Expenditure

Food & Grocery

Rent, Utilities & Education

Fuel, Transport &Communication

2003 2008 20134% 4% 5%

27% 30% 32%

32%

20%

11%

36%

20%

10%

40%

20%

9%

Exhibit VII16 : Share of wallet

410

2008 2013 (P) 2018 (P)

535

755

0

200

400

600

800

1000 Exhibit VIII17 : Growth of Retail (US$ Billion)

1873

170

Retail Modern Retail

16. Technopak Analysis17. Technopak Estimates

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Low labor cost2. India has by far the lowest labor cost compared to many emerging countries giving it an edge for establishing manufacturing base for both Domestic and International FMCG brands. Average labor cost in India is ~US$ 90/month compared to US$190/month in China, US$ 210/month in Thailand and even higher US$1,300/month in Taiwan.

Systemic Drivers for Sectoral Growth

Several other factors are also encouraging for FMCG sector growth in the long run, such as policy change and investments in infrastructure development.

Favorable changes in Government Policies1. The Indian government has been trying to foster the growth of various categories of FMCG by way of making policy changes. Some of the policy changes include:

Automatic investment approval (including foreign technology agreements within specified norms), •up to 100 per cent foreign equity for most of the food processing sector

Quantitative restrictions removed •

Five-year tax holiday for new food processing units in fruits and vegetable processing •Customs duties reduced on plant and equipment, raw materials and intermediates, especially •for export production

Capital goods freely importable, including second hand ones•

De-reservation of most FMCG categories from SSI•

Many states have also begun competing with each other to offer incentives to different sectors •including FMCG, in the form of tax holidays, fiscal incentives, land at concessional rates and subsidies to encourage economic development.

Infrastructure Development2. The government has invested a considerable amount in the Golden quadrilateral project to connect the four corners of the country, of which over 96% has been completed. 50% of existing highways are being improved and expanded. An outlay of Rs. 59,000 crores was earmarked for road development projects in the 10th Plan, between the aforementioned projects as well as projects to develop the National highways (Primary system), the state highways (secondary system), major district roads and rural roads. The railways are also increasing capacity through increasing tracks, improving existing tracks and adding more freight compartments to enable better carrying of goods and products.

Challenges

With the growth drivers in place, there are many issues and challenges the sector grapples with. The key challenges faced by FMCG sector players in India are as follows:

Tax Structure - Complicated tax structure, high indirect tax, lack of uniformity, high octroi & entry 1. tax and changing tax policies.

Infrastructural Bottlenecks - Agriculture infrastructure, power cost, transportation infrastructure and 2. cost of infrastructure.

89

India China Thailand Taiwan US

188 210

1301

2766

0

1000

2000

3000 Exhibit IX18 : Labour cost (US$ per month)

Labour cost (US$ per month)

18. CEIC, Morgan Stanley Research and Investment commission of India, 2008

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Counterfeits and Pass-offs3.

Emergence of Private Labels4.

Regulatory Constraints 5.

Price of Inputs6.

Tax Structure1.

Complicated Tax Structure -i. In India, problems are exacerbated by the complicated tax structure. There is a VAT which is to be levied at state level, there are other state taxes such as octroi and entry taxes and then centre levies excise duties and service tax. As a result, no product cost is exactly the same from one state to the next.

High Indirect Tax -ii. Indirect Tax levels are quite high, especially in light of the fact that the sector provides goods meant for daily consumption. China, for instance, levies a tax of 10%19 on average, whereas in India, the average is around 30%.

Lack of uniformity -iii. Despite VAT states do not implement rates and procedures uniformly. Each state still continues to approach taxation differently, and thus moving goods from one state to another is like moving them from one country into another. The taxation rate policies on many FMCG goods differ from state to state and centre to state. Centre has classified many FMCG products under Merit (VAT exempt) list, such as processed foods, tooth powder, sanitary napkins but states levy on the same products high rate of 12.5%20.

High Octroi & Entry Tax -iv. There are Octroi and Entry Tax at city and state entry points in a few states, which leads to an increase in pricing and affords opportunities for arbitrage. For instance, Mumbai has octroi of 4-6% on goods produced outside of Mumbai. Thus, a bottle of mineral water produced by Coke or Pepsi which have their plants in Thane, which is considered outside the city limits of Mumbai, have to pay this extra charge, while Parle, which has a bottling plant within the city limits does not. So Bisleri is sold in Mumbai for Rs. 12, while Kinley or Aquafina cost Rs. 13, just because of the factory location. This opens up possible arbitrage opportunities, apart from causing a genuine grievance to the consumer.

Changing Tax Policies -v. Tax policies keep changing which makes it difficult to plan for the long term. For instance, tax havens were created in J&K some years ago and many companies opened facilities there. However, recently part of the exemption was withdrawn by the government, thus leading to a sudden hike in costs.

Infrastructural Bottlenecks2.

Agricultural Infrastructure i. - Agriculture infrastructure in India is particularly weak. Firstly, irrigation and modern farming methods are not widespread and thus agriculture in India is at the mercy of nature. Thus, it makes for grossly varying amounts of harvest of critically needed inputs into FMCG manufacture, from one season to the next and one year to the next.

Power Costs - ii. Power costs in India are very high and they contribute substantially to cost of goods sold. They are 3-4 times the optimal costs.

Transportation Infrastructure -iii. To compound this problem is the poor transportation and roadways infrastructure – many of the villages are extremely poorly connected with means of transportation – either road, rail or sea – so the amount of time it takes for the harvest to be transported to the FMCG manufacturers is unpredictable, and results in substantial spoilage of the goods. For example, it costs nearly 12 days to transport goods from Baddi in Himachal Pradesh to South India, a distance of 3000 km. The lack of a cold chain adds to this problem, because it means a tremendous amount of farm output actually rots or gets spoiled in transit. Nearly 8% - 10% of dairy produce is lost to pilferage.

Cost of Infrastructure -iv. It takes almost Rs. 7- 8 crores to lay 1km. of road. Along with this problems in land acquisition due to fragmented land holding further delay development of road and rail infrastructure increasing the cost associated

19. Mr Rajan Verma, CFO, Dabur India Ltd20. Mr. Krishnan S, Parle Agro

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Counterfeit and Pass-offs3.

Counterfeit products are another issue for the FMCG sector. Taking advantage of the lack of literacy and consumer knowledge, several small manufacturers churn out spurious products which they label akin to the big brands, Lifeboy or Lax soap or Fivestare chocolate bars, Vicky balm, for instance. These spurious pass off products affect large, high quality brands which have actually invested money in research and development to create their products and build brand equity. These account for almost 10% - 15%21 of the total sector revenue and pose serious challenge to its growth and also impact government’s tax revenue significantly. But the only recourse available to FMCG manufacturers against counterfeit and pass off products is to file an FIR. There are no Bureau of Industrial Standards norms laid out for each product category which could help prevent the mushrooming of counterfeit products. And an FIR results only in local action, if at all, while the source of the counterfeit products continues to remain in existence.

Emergence of Private Labels4.

Apart from the pressure on margins, the biggest fear of FMCG players when facing MR is the introduction of private labels or own brands. The fear is justified because world over, private labels have served to lower the consumer’s price points, particularly at the mass level. Moreover, there are inevitable conflicts of interest when a retail chain has its own label whose packaging looks like category leaders’ and stocks brands of other manufacturers, in terms of display space, promotions etc.

A Technopak analysis undertaken across product categories revealed that private labels could constitute as much as one fourth of all sales in the FMCG category by 2011. While the exact year could shift marginally, there is no denying the fact that private label FMCG goods will be here and will constitute a formidable threat to add to the already fierce competition in the FMCG category. Brands which currently appeal to price conscious value shoppers will be facing the highest risk with advent of store brands.

Regulatory Constraints5.

State borders cause a lot of delays and it is common for 2-3 days of finished goods inventory out i. of 20 -30 days’ total stuck on various state borders due to a requirement for multiplicity of permits and licenses.

The Indian labour laws were drafted in the 1940s and take no note of modern manufacturing ii. methods and strategies. They need to be changed on a more dynamic basis to reflect present realities.

There is lack of uniformity in definitions, and these do not follow international norms either. Currently, iii. drugs and cosmetics come under the same set of laws when in fact they need to be treated differently. Weights and Measures used under FDA do not conform to those under the Weights and Measures Act followed in India. Some products come under the OTC category internationally but come under Schedule H drugs in India, requiring doctor’s prescription and require to be distributed only in drug licensed stores

Acquiring manufacturing licenses is a long and painful process, beset with red tape and corruption. iv. It takes 10-12 months to get multiple licenses and to set up a manufacturing unit.

Reservation of jobs for employees creates many problems. For instance, Himachal Pradesh has v. a reservation of 70% of jobs for people domiciled in Himachal Pradesh. Since they are few in number, attrition happens for as little as Rs. 50 pm, and it becomes a problem to maintain the requisite labour force.

Export procedures are cumbersome and lengthy. There is no single-party interface so multiple vi. departments and officers have to be followed up with to get the requisite licenses. A transport permit has to be sourced for each consignment rather than assigning a blanket permit for a period of time.

Subsidies are announced by the government but to avail of them is both confusing and time-vii. consuming.

Firstly, the amount of subsidy is restricted to Rs. 50 lakhs, regardless of the total quantum of a.

21. FICCI-BPC initiated ORG study

12

investment required by a project. Thus, if large projects and small get the same incentives, large projects may not find takers.

Secondly, the release of the said monies is not time-bound and gets done in an ad-hoc b. basis.

Prices of Inputs6.

Commodity prices fluctuate, which make it difficult to finalise raw material prices, affecting the final i. price of the product. The petroleum price fluctuation also impacts the cost of supply of materials. As a result, the entire supply chain dynamics need to be constantly planned afresh with the changing prices.

Indian consumers are more price-sensitive and value conscious, making it difficult for FMCG firms ii. to pass on the increased costs, leading to depressed margins.

Opportunities

Low Category Penetration at present1.

Penetration of many product categories is still low. Even amongst those where the penetration is higher, the per capita consumption is comparatively low, thus offering scope for high growth in the future.

The FMCG sector has been investing time, effort and money in an increasing effort to penetrate upcountry and rural markets. Over time, the demand from rural India for FMCG products has come to constitute 45% of the total demand for the category.

Market penetration has been one of the focus areas of the category, and thus sachet-isation of a variety of product categories has been the norm. Providing consumers with ‘bite-sized’ or single-use packs of their favourite products has resulted in more consumers being able to afford to try out these products. As their incomes grow, they either shift to more frequent buys of the products or to buying larger multi use packs.

Impact of Modern Retail on FMCG Sector2.

The advent of modern retail into any market, worldwide, has always made for a time of upheaval for many product categories, including FMCG. Modern retail can have many benefits for different product categories, including greater penetration, wider product range, the ability to display the range, direct interaction with the consumer and with the product, the ability to run specific promotions for specific regions etc.

Investments in Modern Retaili. Currently the plans of the top 10 leading players alone include an investment of over US$ 30 billion (Rs 144,000 crores) from 2008 – 2013, and their combined turnover should top US$ 100 billion (Rs. 480,000 crores) by 2013-14. The plans of many of the current players involve a large play within FMCG items, as these are critical items for any household and thus would form a compelling reason for the consumer to be drawn towards modern retail stores.

Category Penetration All India % Urban % Rural %

Toilet Soap 91.5 97.4 88.9

Detergent Bar 88.6 91.4 87.4

Washing Powder 86.1 90.7 84.1

Toothpaste 48.6 74.9 37.6

Shampoo 38 52.1 31.9

Utensil Cleaner 28 59.9 14.6

Skin Cream 22 31.5 17.8

Instant Coffee 6.6 15.5 2.8

Deodorants 2.1 5.5 0.6

Table II22 : Category Penetration in India

22. HUL Presentation, 2008

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Increasing FMCG share in Modern Retailii. What is of more interest to FMCG marketers, however, is to understand what percentage of total FMCG sales are expected to come from modern as opposed to traditional retail. As per Technopak estimates the penetration of FMCG in Organised retail will consistently grow from current 6% to ~15% by 2013 and further increasing to ~25% by 2018.

The value of total sales would increase in both traditional and modern sales, due to growing affluence of consumers and an increasing shift towards packaged and branded goods. However, around 1/4th of the FMCG size would be corralled by modern retail.

This represents a very significant influence of modern retail over the FMCG sector, particularly if one keeps in mind that the bulk of modern retail would be in urban areas where they could control a much larger percentage of FMCG sales.

But this in no way undermines the potential of traditional formats simply because the larger share is still estimated to be retained by traditional formats; at least in the next few years apart from the sheer industry size which would be much larger translating into larger shares for both traditional and MR.

Goods & Service Tax (GST) Implementation3.

A Goods and service tax has been proposed by the Government, to be introduced by 2010, with a tentative rate of 16% being mooted at present. This would replace the multiple indirect taxes currently being levied on FMCG products. A GST would have several beneficial effects, including:

Uniform taxation -i. the rate of taxation would be the same across all geographic boundaries of India and thus would eliminate the opportunity for arbitration as well as provide goods at a uniform rate everywhere in India

Simplified taxation -ii. calculating a GST at a uniform rate would be much easier and it would make adherence to the proposed tax simple

Single point taxation - iii. rather than a multiplicity of authorities to deal with, a single-point taxation could be dealt with through a single-point window thus creating greater efficiency and speed of operation within the system

Solve issues related to holding Regional warehouses -iv. a GST would do away with the need for regional warehousing, thus freeing up greater margins to be either distributed to retailers, FMCG firms or consumers

Reduce inventory in transit - v. the amount of inventory held in transit is considerable at present, due to the multiple check-points and authorities involved in the tax and clearance processes. GST would reduce the amount of inventory in transit, creating greater operational efficiencies and reducing working capital needs for FMCG firms

Increase penetration of FMCG products -vi. the prices of FMCG products would fall if the overall tax rate is reduced to 16% GST as proposed. This would expand consumption base and also enable current consumers to consume more of the goods they need and want, thus improving the lifestyle of people.

23. Technopak Analysis24. Technopak Analysis

Exhibit X23 :Investments by Retail Format ( 2007 - 2014)

Exhibit XI24 :FMCG Share in Modern Retail

Other Formats28%

Stocking FMCG72%

6%

94%

15%

85%

75%

25%

Modern Retail

2008

2013

2018

Traditional Trade

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A GST at 16% would reduce the per unit tax paid, but due to its cascading impact on lowering end-prices to the consumer, it would result in an increase in volume of sales which would have the effect of actually raising tax collections over time. An example of this can be seen in the impact of reduced excise rates over the years and the sales of the affected sector:

Taking a cue from the above price-decline indications in Table above, reduced indirect taxation i. incidence on FMCG products, from the current ~30% on sale price to the proposed 16% will reduce price of product by 10% – 12%, resulting in an incremental volume sales growth of almost 20%, especially for products with low penetration.

This increase in sales volume will increase government tax revenues at least by 15% - 20% from ii. the current collection levels. Referring back to the attached table, in 93/94 the excise duty was 70% which came down to 30% in 97/98. Therefore over 4 years prices of toiletries got reduced by 25% (100 – 130/170) but excise collection on toiletries increased from Rs 130cr to 396 cr or 51% p.a. on an average over the same period. With no excise driven price reduction i.e. over 97/98 to 99/2000 avg excise revenue growth was 14% pa. So incremental volume due to price reduction revenue collection growth of 37% p.a. (51% - 14%) can be attributed to price reduction.

Amplified growth of FMCG sector –vii. The proposed rate of 16% GST can mean 10% - 12% reduction in retail prices of FMCG products and hence increased volumes and value for the FMCG sector. GST implementation can give a very significant growth fillip to the FMCG sector. As per Technopak analysis, GST implementation can speed up the growth of FMCG sector.

Zero Central Sales Tax (CST)4. CST has come down from 4% in 2007 to 2% at present. A reduction to 0% by 2010 is widely expected to be on track. With Zero CST implemented, companies can setup large distribution warehouses and hubs as there will be no inter-state tax levied with zero CST. This would require redesign of their current distribution network including modernisation of key warehouses. Modernisation of key warehouses is strongly recommended because of

Large sizes and more complex operationsi.

Increasing level and variety of service required by customers especially modern retailersii.

Increasing scarcity of skilled labour and real estate requiring vertical and mechanised iii. warehouses

Year Excise Duty % Excise Revenue (Rs. Crore)

1993-94 70 130

1994-95 50 208

1995-96 40 228

1996-97 40 300

1997-98 30 396

1998-99 30 475

1999-2000 30 540

51.1% per Annumavg. Growth

14% per Annumavg. Growth

Table III: Excise Duty rate and Revenues in the Toiletries and Cosmetics Industry 25

Exhibit XII26 : FMCG Industry Category Breakup

0

20

40

60

80

100

Scenario 1: With no change in industrystatus, almost 12% YOY growth rate

US$

Billi

on Growth Rate of 12%

25

2008 2013 2018

43

74

0

20

40

60

80

100

Scenario 2: FDI opened in Multi-brand retail + GST implemented, 15% YOY growth rate

US$

Billi

on Growth Rate of 15%

25

2008 2013 2018

50

100

25. ISTMA26. Technopak Analysis

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Besides leading to redesigned distribution network, Technopak estimates it would lead to many other benefits like:

Savings of almost Rs. 7 – 10 crores for a company with revenue of Rs. 2000 cores i.

5% - 10% net savings in logistics and inventory carrying costsii.

Simplified planning and reduced warehouse and C&FA managementiii.

Improved service levels to all key customersiv.

To Sum up

The FMCG sector has a tremendous opportunity for growth in India, with the growing population, the rising incomes, education and urbanization, the advent of modern retail, and a consumption-driven society.

However, successfully launching and growing market share around a branded product in India presents tremendous challenges. Many of these challenges raised have to do with operational inefficiencies – an ambiguous and inconsistent tax regime, bureaucracy, hazy and outdated legislation as well as infrastructural bottlenecks.

These need to be overcome not only through a concerted effort by the industry but with active government intervention and promotion to ensure that the sector is able to perform as per its potential.

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Chapter 4

Recommendations to Stakeholders

Recommendations for FMCG players

Strengthen Consumer Understanding -1. Deep consumer understanding will always be at the heart of FMCG. Especially during the current downturn, it is critical to know and respond to changing consumer and shopping behaviour. More sophisticated and rigorous tools need to be applied. For example, our research finds that in some metros, there is a rising demand for higher end home consumption food products, as consumers eat out less and compensate by eating better at home. This presents an opportunity for the FMCG firm with its finger on the consumer’s pulse.

Improve Engagement with Modern Retail - 2. There are large synergies for FMCG companies and Modern Retail if they work closely together. Some areas include:

Key Account Management – Appoint account managers to work with retail partners. Together, •create plans on everything from stocking practices to display, pricing and in-store promotions. Improve fill rates with Modern Retail, which are currently very low at ~60%.

Category Captainship – FMCG companies can manage a product category for the retailer. The •retailer benefits from the manufacturer’s expertise in their categories, and the manufacturer through increased sales volumes.

Collaboration - Developing a brand exclusively for a retailer enabling the retailer to offer unique •products / offers to the customer and saving marketing costs to the manufacturer

Make the most of zero CST –3. CST has come down from 4% two years ago to 2% at present. Reduction to 0% by next year is expected to be on track. Currently, most companies have a warehouse and C&FA in every state to avoid paying CST. With zero CST, companies can set up large distribution warehouses and hubs, as there will be no inter-state tax levied. Besides leading to redesigned distribution network, Technopak estimates it would lead to many other benefits like:

5% - 10% net savings in logistics and inventory carrying costs•

Simplified planning and reduced warehouse and C&FA management•

Improved service levels to all key customers•

Invest in product innovation -4. Rising competition and the need to differentiate would require FMCG companies to step up spends on product design & innovation. Spends on product design have gone up almost 15% of the total R&D spend over last year.

Recommendations for Retailers

Traditional retailers - 1. Invest in customer service, product display and store ambience.

Modern retailers -2. Work with FMCG brands to improve fill rates, better capture consumer and shopper

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Recommendations for the Government

Implement GST as per current timelines – 1. Rapid implementation of GST to replace the multiple indirect taxes currently levied on FMCG products will have several benefits including uniform, simplified and single point taxation and reduced prices to the end consumer. Consumption growth and improved tax compliance will result in an increase in tax collections.

Active participation in building infrastructure - 2. This will ease distribution and help industry perform to its full potential. An outlay of around US$ 12 billion (Rs. 59,000 crores) was earmarked for road development projects in the 10th Plan for golden quadrilateral and national highway development; however a lot more is required to develop adequate infrastructure to avoid transportation delays, pilferage and increase in product cost. For instance:

Due to multiple processing units; 8% - 10% of dairy produce is lost due to pilferage•

There are only 1-2 cold chain companies charging high transportation charges•

Enforce Trade Mark and Copyright Laws – 3. This is essential to drastically reduce counterfeits, and protect the rights of the consumers and FMCG companies.

Modernize Labour Laws – 4. This will enable Indian manufacturers to improve efficiencies, serve Indian consumers better and also grow exports from India.

Albert Einstein once famously said, “In the middle of every difficulty lies opportunity.” As happens in a crisis, new truths are revealed, sometimes not always pleasant. The current economic downturn has proved challenging for a number of industries. However, the FMCG sector does have significant growth opportunities in the coming years. Companies that make the right choices are the ones that will win in such times!

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About Technopak

We are a management consulting firm with a difference. Founded in 1991 on the principle of “concept” to “commissioning”, we are in the top 5 consulting firms in India by revenues. We are strategic advisors to our clients during the ideation phase, implementation guides through start-up phase, and trusted advisors overall. The industries we serve include Retail, Consumer Products, Fashion (Textiles & Apparel), Healthcare, Hospitality & Tourism, Leisure & Entertainment, Food & Agriculture and Education.

Our team currently comprises 300+ skilled professionals, from leading International and Indian engineering and management institutes. Most of our consultants have hands-on industry experience in their fields of specialization and represent a wide variety of functional backgrounds. This enormous knowledge and talent pool enables us to create customized teams for each project based on client requirements.

Technopak continues to keep up the impressive track record of helping clients improve their performance in tandem with their mission, values, objectives and market realities of their industries. Our 600+ clients are leaders in their market sectors and include leading Indian and international businesses, entrepreneurs, investment houses, multilateral development bodies and governments.

At Technopak, we foster innovation and creativity which challenge conventional thinking and generate practical and far reaching solutions for our clients. In 2008, we worked with over 130 clients across 180+ projects, in 20 countries besides India, across 5 continents.

Our key services are:

Business Strategy. Assistance in developing value creating strategies based on consumer insights, competition mapping, international benchmarking and client capabilities.

Start-Up Assistance. Leveraging operations and industry expertise to ‘commission the concept’ on turnkey basis.

Performance Enhancement. Operations, industry & management of change expertise to enhance the performance and value of client operations and businesses.

Capital Advisory. Supporting business strategy and execution with comprehensive capital advisory in our industries of focus.

Consumer Insights. Holistic consumer & shopper understanding applied to offer implementable business solutions.

Services we offer in Management Consulting

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Services we offer through our Group Companies

Holistic consumer understanding applied to offer implementable business solutions revolving around shopper insights, trend insights, design and innovation insights, marketing communication and measuring customer delight.www.indiamindscape.com

Insights and innovation led product, packaging, space and strategic design, including design research, concepts, engineering and prototyping. A blend of unique, contemporary and relevant concepts and solutions. www.foleydesigns.com

Planning, implementation and project management of plants, warehouses and entertainment centers with a focus on modernization, process improvement, technical valuation, power & water audit and environmental engineering.www.technopak.com/engineering

Engineering

Strategizing, planning and managing creation, development and growth of brands through a scientific, transparent and process-driven methodology.www.vertebrand.com

Services we offer through our Strategic Partnerships

World’s largest privately held real estate services firm. We offer, through them, comprehensive retail real estate solutions to our clients.www.cushwake.com

UK’s leading design consultancy for developing brand environments. We offer, through them, design solution for retail environments.www.dalziel-pow.co.uk

Global research and consulting firm specializing in the study of human behavior in retail, service, home, and on-line environments. We offer consumer and shopper insights.www.envirosell.com

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About FICCI

FICCI is the rallying point for free enterprises in India. It has empowered Indian businesses, in the changing times, to shore up their competitiveness and enhance their global reach.

With a nationwide membership of over 1500 corporates and over 500 chambers of commerce and business associations, FICCI espouses the shared vision of Indian businesses and speaks directly and indirectly for over 2,50,000 business units. It has an expanding direct membership of enterprises drawn from large, medium, small and tiny segments of manufacturing, distributive trade and services. FICCI maintains the lead as the proactive business solution provider through research, interactions at the highest political level and global networking.

FICCI FMCG committee To represent the FMCG sector, with a tremendous growth opportunity, FICCI constituted a committee which is actively involved in various trade & policy matters concerning FMCG Sector. Since its inception, the committee has worked persistently on various issues concerning FMCG Sector, be it representations on rationalization of VAT, issues on normative pricing and harmonization of labeling provisions etc. The committee through its representation in various empowered committees and inter ministerial working groups of the Government, has effectively served the cause of this sector at the highest level

Chairman - FICCI FMCG committee Mr. Shantanu Khosla Managing Director Proctor & Gamble India Co Chair - FICCI FMCG committee Mr. Kurush Grant Chief Executive (FMCG & Tobacco Business) ITC Pvt Ltd

Mr. Saugata GuptaCEO-Consumer ProductsMarico Limited

FICCI SecretariatMr. Sameer Barde Senior Director FICCIPhone: +91 11 23738760 (Extn 221 & 424) email: sameer@ficci.com

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Authors

Raghav GuptaPresidentraghav.gupta@technopak.com+91 9958 522 993

Pratichee KapoorPrincipal Consultantpratichee.kapoor@technopak.com+91 9891 449 806

Inderpreet KaurSenior Consultantinderpreet.kaur@technopak.com+91 9810 157 562

Shray ChughResearch Associateshray.chugh@technopak.com+91 9971 406 888

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Notes

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