forbes india magazine - decoding the detail in retail

7/29/2019 Forbes India Magazine - Decoding the Detail in Retail

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Decoding The Detail In Retailby Rama Bijapurkar , R Sriram, S Raghunandan

Why there is no need for great celebration or for deep despair over FDI in retail

Image: Amit Verma

INDIA CALLING Global retailers would be interested because of the presence ofa large and growing consumption-driven economy, a young consumer base, and a consumer who is ready, waiting and underserved

uch has been said and written about what foreign direct investment (FDI) in retail can

do. Depending on which side ofthe ideological divide is speaking, the assertions are

either that it is a magic wand to fix many big problems or that it is a destroyer ofhonestlivelihoods, with little benefits ofits own. What is common to both sides is that they are mostly

low on fact, high on opinion and generate enormous amounts ofconfusion. Which is why, we

think it is necessary to sift through all ofthe noise and look truth in the ey e. The facts, as we see

it, tell us that it has become a symbolic issue, far beyond what reality demands it ought to be;

and that there is no need for either great celebration or for deep despair over the idea that FDI

in retail is

now a reality. Our analysis tells a fairly straightforward story.

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The government has hugely exaggerated the quantum and immediacy ofbenefits it put on the

table to sell the policythat aam admi consumers will benefit enormously, employment

generation will be huge, the countrys supply chain will be transformed and large numbers of

small producers and farmers will gain. As things stand, even ifmodern retail were to take offon

all cylinders, these arguments would still not hold water for the next 10 years.

For one, there is the fact that aside from very old markets like America and Europe, in most

newly developed markets, modern trade accounts for only 20-25 percent ofall retail. India isalready at 8 percentwhich is significantbut the impact hasnt been as dramatic as one would

have assumed.

Then there is the fact that the economics ofthe Indian market is such that it makes little sense

for global retailers to focus on all consumers. Were convinced they will focus their energies on

the top 33 percent ofurban Indian households (a mere 10 percent ofall Indian households);

investing in the others isnt quite what they know how to do profitably yet.

As for small manufacturers, we dont see that huge numbers ofthem will benefit. Retailers

across the world like to work with a small group ofselect vendors because it makes for better

profitability. So yes, a small number will benefit significantly. And yes, employment will be

generated. But it wont be anywhere close to the numbers now being touted.

Then there is the argument that encouraging modern retail to invest will provide the much-

needed booster shot for the countrys dismal supply chain infrastructure. Here again, lets face

it. Retailers arent in the business ofbuilding national infrastructure. About the only

infrastructure theyd be interested in is their last mile.


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The only argument that holds true is that kiranas or the small, traditional shopkeepers who are

now an Indian staple, will not die. But that is a tribute to the small shopkeeper rather than

prescience on the part ofthe government.

A more honest case for FDI in modern retail would be that it will lay the foundations for a new

industry, guaranteed to grow for at least the next five decades. Do we need it? The question is

rhetorical. Did we need cheaper air travel, more television entertainment, cellphones, air-conditioned cars?

Now that weve stated our assessment upfront, wed like to explain how and why we came to

these conclusions.

#1: What will FDI do?

Without doubt, it will immediately save the indigenous modern retail industry that has been

built until now. What has been built until now? Between all the modern retailers in India, they

now manage to generate Rs 2 lakh crore in revenuesa very impressive number by any

reckoning and growing at a compounded rate of25 percent each year, according to India Retail

Report 2012 from Images. But the problem is, most players in the Indian retail business justarent making any money yet, and are carrying large amounts ofdebt, not having had enough

equity to fund business losses that are par for the course in the build-up phase ofretailing

businesses.

Retail businesses guzzle a lot ofcash for a long time and then return it handsomely. Ifnot

carefully funded with patient capital, ofthe equity kind, the investment phase can be life

threatening.

Kishore Biyani, the largest, most ambitious modern Indian retailer, is a victim ofprecisely thisphenomenon. His business managed to generate Rs 14,000 crore in sales, but in the process

incurred expensive and debilitating debt ofalmost Rs 9,000 crore. Just paying offthe

accumulated interest was wiping out all the profits the business was generating.

Unable to sustain the business, he was forced to sell a part ofit to the competing Aditya Birla

Nuvo group, and reduce debt to a manageable amount. However, his business still needs a lot of

money to grow to get to serious profitability.

Biyani is not alone. Foodworld, the first Indian supermarket chain, and one that consumers

loved, languished at a boutique scale by modern retail standards, with 60 stores mostly in SouthIndia, and lost all early-mover advantages and is now a minor player. Shoppers Stop has just 52

stores in 21 years ofoperations. In contrast, T esco, for example, has 3,054 stores in just the UK

with revenues of42 billion in 2011. In India, a country that is so much bigger, all modern

supermarket and hypermarket stores put together would not add up to this number.


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Image: Madhu Kapparath for Forbes India

DEEP POCKETS Many ofthe top global retailers, like Walmart, are already in India. For them, the patient capitalneeded to invest in India is hardly a bother

With the exception ofthose in the luxury retail business, like Louis Vuitton, Armani or Gucci,

the others follow a fairly straightforward model. You buy cheap from suppliers because you buylarge volumes. Because you buy cheap, you can sell cheaper to consumers than traditional

retailers, who are handicapped because they are small volume players. Ten Food Bazaars, for

instance, would buy 200-300 times as much food and grocery than any ofthe large kiranas.

This is only on the food and grocery side, and does not include fresh produce, which hardly any

kirana deals with.

The trouble is that while you build the large volumes that can help you buy cheap, you have to

keep fuelling the business with money. You need to do everything right at the stores, including

pricing (or front end as retailers call it), in order to attract consumers and establish your brandpositioning; and invest in all the support systems needed to run the stores (the back end). It is

only when you achieve a certain scale that you pare down the cost ofsupplies to a point where

margins improve and profits begin to come in. Biyani had to sell before he got to this stage.

And then there is the fact that retail is as much science as it is money. For instance, scaling the

business isnt just about expanding across the country by building more identical stores with

identical merchandise, but about knowing where to build a new one, when, and how to minimise

risk. All ofthese are lessons global retailers have figured over the years and will bring to India.


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To accrue scale benefits, evolved retailers know when to scale by penetrating existing

catchments and when to scale by entering new catchments. They also know what is the

minimum number ofstores they must enter a new catchment with. They know how to tailor the

merchandise mix and range to local needs when they build new stores, without messing with the

economics or the brand proposition. They have very sophisticated analytics to decide store

locations, something we havent done well at all in India.

#2: Whos got the money?

The kind ofpatient capital that the retailing

business needs is not what finds favour with

financial investors. It has to come from strategic

investors.

Global retailers whove already wet their feet in

other parts ofAsia and the Middle East are the

most likely source ofFDI into Indian retail. Large

global retailers include the likes ofWalmart,

Carrefour, Target, Metro, Ikea. Incidentally, most

ofthe top 10 retailers in the world are in roti,

kapda aur makaan (food, clothing and home)

categories. Only two do not participate in the food

and grocery business at all. They are Walgreen,

which is into health and beauty products; and

Home Depot, which, like the name suggests, is into

products for the home, but with a Do-It-Yourself

slant.

The top 10 aside, there are at least 50 smaller

retailers who have built distinctive brands and

operate at varying price-quality points. They

could be inclined to consider India as well.

Our guess is it could be fashion retailers like H&M

and Gap, home retailers like Ikea and department

stores like Lotte, durables and electronics retailer

Best Buy and sports good stores.

Many are already in Indialike Zara, Timberland,

Marks & Spencer and Body Shopthough theyve

still to shift into high gear despite the potential

opportunity (see graphic Who is Coming).

Which begs the next question: Why would they be

interested? The answer is not far to find. A large,


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growing, consumption-driven economy, a slowing

down ofgrowth in developed markets, a young

consumer base, and a modern retail race that has

not even seriously begun yet, is a once-in-a-half-

century opportunity. And a consumer who is

ready and waiting and underserved.

Ifwe think beyond food and grocery that is servedby the ubiquitous kirana stores, we can see all the

yawning gaps in the market where the consumer

is ready but the retailer is barely present.

As we gadgetise our homes, there is no deep, large

national multi-brand consumer durables retailing

chainCroma is still fledgling with 78 stores across

15 cities.

In a country that makes 21 million babies a year, and where seven out of10 homes have a child

at home, there is no deep, large national childrens products retailing chain or even a toys

discount retailing chain. There is no ubiquitous national pharmacy chain with store brands for all

our everyday ailments.

Do big global retailers have the deep pockets needed to invest and stay the course?

Walmart most certainly outstrips everybody on this count; it has revenues close to 30percent ofIndias GDP ($421 billion in 2011) and an annual profit of$16.3 billion. But theothers are very well heeled too.

Target has revenues of$67 billion and profits of$2.93 billion.In the consumer durables category, Best Buy makes a profit of$1.3 billion.Ikea and fashion retailer H&M are hugely profitable by modern retail standards. Ikea makesan annual profit ofaround $3.85 billion on a $31 billion turnover, and H&M makes a

whopping $2.33 billion on a turnover ofjust $15 billion.

Between the top 20 global retailers, they had a net income of$57.7 billion on total revenues of

$1.7 trillion last year. For them, the patient capital needed to invest in India is hardly a bother.

Despite a slowdown in the developed world, most ofthe top 20 have grown their large revenuebase in the region of3 to 9 percent in 2011. They also have the stamina to correct mistakes and

start over again ifneed be. Two examples ofthis: Puma and Marks & Spencer.


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Image: Madhu Kapparath for Forbes India

THE SUPPLY CHAIN Modern retailers are interested in saving on every bit of cost. To do that, theyd much ratherconsolidate vendors. However, the supplier base will be larger than elsewhere because of regional diversities inconsumer preferences

Puma first entered the country in the mid-1990s through a franchise arrangement with Carona.

This did not work out and they terminated the agreement and appointed a new franchiseePlanet Sports. However, the brand did not have control over the stores or pricing, and this

arrangement too failed.

Finally, in 2006, Puma decided to enter directly, with a 51 percent stake and with full

management control. The brand carried out some very innovative marketing initiatives, like

digital marketing (Puma India went on to Facebook in 2008, a practice adopted by Puma USA

later), and controlled the retail environment. Unlike its competitors like Reebok and Nike, Puma

went with a mix of70 percent lifestyle and 30 percent sports performance, which was almost

the reverse ofits competitors. Apart from all this, Puma appointed a local Indian management,and gave them a free hand. The result: 240 stores and expanding, and a 44 percent growth rate

over the last few years.

Marks & Spencer had a similar story. The franchisee opened small stores (average size 3,000 sq

ft) and positioned M&S as a premium brand, which led to a disastrous performance. M&S

recently entered into a JV with Reliance, where the brand has 51 percent and management

control. It repositioned itself, in line with its global DNA, as being a value for money, staples

brand. Now M&S is growing rapidly. Stores are also being right sized at about 20,000 sq ft each


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#3: How much money can be absorbed?

Various numbers have been thrown around. Some

claim retail can attract FDI in the region of$20

billion. Then there are the more optimistic ones

who believe it could go up to as much as $50

billion.

One way to test this wishful thinking and anchor it

in reality is to ask how many consumers are out

there, where FDI is permitted, with the muscle to

buy from these stores when they come in? What

kinds ofmonies are needed to go after this

opportunity and turn in profits for investors? And

how long would these investors have to wait?

To compute these answers, we looked at nine

types ofretail formats that form the pillars ofmodern retail. These include the cash-and-carry

format that serves small retailers as opposed to

direct consumers; food- and grocery-driven

hypermarkets; home; fashion and apparel;

speciality stores and so on.

In each category, we compiled a list ofretailers

with a presence in Asia and the Middle East and

hence would want to get into India as well.

Surprisingly, many were already in India either

through franchises, licensee agreements, sourcing

operations and seemed familiar with the country.

We then looked at some key parameters. These

included the price-quality range at which they

operate, their strategic market positioning (that is

where in relation to the plethora ofcompetitors do

they typically peg themselves), their brandpromise, and store formats. Assuming they

wouldnt change their DNA just to get into India,

we attempted to assess who could possibly form

the consumer base for each format.

Food- andgrocery-driven hypermarkets likeWalmart, Carrefour etc, and appareldrivendiscount retailers like T arget, have the ability to


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target andserve the top 60 percent ofurbanhouseholds by income (which wouldbe the Socio

Economic Classes A, B andC ofthe five pointstandard industry socio-economic classification,or SEC, system that consumer marketers in Indiause).Other mid-market players (like BedBath &

Beyond, Victorias Secret, Ikea), we believe, will

be able to address only the top 33 percent ofincome earners (SEC A andB).

Many ofthe speciality stores that hawk fashion apparelandaccessories are likely to berelevant only to the top 10 percent ofall income earners (SEC A).

These assessments in place, we tried to estimate how many stores ofeach kind the top 40

Indian cities could support, given the store formats typically used. We concluded, for example,

that a proposition like Ikea can at best set up 30 stores across these 40 cities. As for

hypermarkets, we reckon these 40 cities can support at least a 1,000 ofthem. (See graph The

Foreign Investment Inflow)

Based on these numbers, we are convinced there is an opportunity to add another $25 billion in

revenues to the $45 billion that already exists. To fulfil the demands this opportunity presents,

retailers will collectively need to invest in the region of$12 billion, which includes infrastructure

and people.

What it means is FDI in multi-brand retail will be in the region of$7 billion because the

government mandates a 51 percent cap on all such investments. And multi-brand retail is where

the money and big boys are. Then there is the fact that there arent enough malls that can

enable business in this format. To build the malls, our estimate is, another $12 billion will be

neededa significant part ofwhich can come in through the FDI route.

Ifthis be the unserved market opportunity today, it would be safe to assume the opportunity

will be even more robust in the next decade. That is because in nominal terms, the incomes of

the top 30 percent in urban India will double in about seven years.

Ifthese numbers are looked at from a holistic perspective, investing $25 billion NOWinto retail

and real estate gives you the muscle to reach out to a $140 billion market opportunity in the

next 10 years. ($45 billion existing market + $25 billion unserved opportunity; doubled over

the next 10 years.)

#4: Will all these stores get built?

In a perfect world, wed have predicted very confidently that they wouldespecially because

many ofthe entrants have been in India for a while in some form and are done with their

learnings on the ground. But there is a big hitch to that happening. Hitch is, there is no real

estate. And without real estate, all ofthese investments arent possible. It is ironic that

consumer demand, historically the bane ofinves ors into India, is ready and waiting, but it is the


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supply that has many roadblocks.

In our experience, building a mall takes three to four years. Conservatively, that means it will

take another five years before modern retail in urban India can go into full throttle.

To exploit this opportunity over the next 1 0 years100 million sq ft ofspace is needed. A recent Jones

Lang LaSalle report says the current stock ofmall

space is 62.5 million sq ft, only halfofwhich

qualifies as superior grade. They make the point

that the inferior grade malls are essentially ruins

ofhastily commissioned projects where no retailer

wants to set up store.

As a result, they say, the vacancy in prime

operational malls is in low single digits! They argue

that retailers, especially large format ones, have

been looking for quality space outside malls and

retrofitting them. But even these spaces are

getting scarce. Several mall projects were

announced around 2005 by a variety of

developers. But over halfhave not seen the light o

day. Mall developers are realising that malls need

to be treated as an asset to be owned and

enhanced to suit the retailers need and notsomething that can be sold like other kinds ofreal

estate. This new-found understanding is pushing

them away from projects theyve announced in the

past.

#5: What about the SMEs and farmers?

What about them? FDI coming in isnt going to

make life significantly different for most ofthem.

Modern retailers are interested in saving on every

bit ofcost. To do that, theyd much ratherconsolidate vendors. Because ofregional

diversities and state-level differences in

consumption and consumer preferences, the

supplier base for modern retail in India will be

larger in number and smaller in turnover than

elsewhere; but even a large hypermarket is likely

to have no more than 2,500 vendors, and apparel

producers may have no more than 100. They, in


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turn, will need to benefit from economies ofscale if

they are to produce at the price, and with the

stringent quality parameters that the retailer

specifies.

Our estimates lead us to believe that ifall the

numbers ofstores we talked about earlier actually

got built, studying the sourcing strategy thatglobal retailers have used in other countries and

the number ofvendors that some ofthem have

already registered in India, there wont be more

than 20,000 SMEs with turnovers in the region of

Rs 50 lakh to Rs 2 crore doing all the job.

An often touted argument is that Indian suppliers

can be a source for the rest ofthe world. The same

consolidation logic would work even more acutely

in this case. Even ifyou assumevery unlikely,

but let us assume itthat double the number of

SMEs will be a part ofthe modern retail journey,

thats still only 40,000 ofthem. In a country with

13 million SMEs, this is still a drop in the ocean.

This model ofsuppliers is analogous to that in the

automobile industry where vendors and suppliers are few, but theyre large, and partners in the

business. They grow as the manufacturer grows. The vendors on their part may sub-contract

their work to smaller vendors. But it is a well-defined vendor orchard, which yields more fruitover time, but not more trees.

Imports may or may not be a large percent ofsales. But a cursory look at non-food goods

flooding India from Chinese shores compel us to believe goods made elsewhere and tailored for

the Indian market will happen, ifoperations are cheaper and easier to manage from elsewhere

in the world.

As for farmers, it is much the same. To supply everyday vegetables to the top 40 cities, 2 lakh

hectares ofvegetable farm will be needed. That is just a small fraction ofthe 1 1 million hectares

ofvegetable farms India has. Two lakh hectares ofvegetables need just two lakh farmers. In thelarger scheme ofthings, insignificant again! There will also be large aggregators, ifthere is

benefit in sourcing from small farmers or suppliers, and one kind ofmiddle man will get replaced

by another, but hopefully a less exploitative one.

Will the country s cold chain get established and will granaries get modernised as a result ofFDI

in retail? Unlikely again because each retailer will invest only what their business needs. To use

an analogy, retailers will invest in building the last mile road to their facilities, but are unlikely to

contribute to building the nations road network. T here are some things that the government


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alone can and must do on its own or encourage through separate policies. FDI in retail will not be

the magicwand for preventing things like losses offarm produce due to wastage or spoilage.

Just for the record, FDI in cold chains was allowed a while ago. But nothing really came ofit.

Image: Getty Images

REALTY CHECK Real estate to build large format stores such as this Ikea store in France is scarce and expensive in

India. Going to far flung locations on the outskirts ofthe city is not viable because public transport is poor

#6: And jobs?

Investments of$12 billion will generate direct employment ofabout 700,000 jobs, ifyou

actually add up how many front-end jobs will be created to work in the number ofstores that we

talked about earlier, and the back-end jobs needed to run the business. Perhaps another

200,000 jobs in the 20,000 strong vendor community that we estimated.

The number ofthese jobs here will definitely grow as the turnover ofthe vendor increases, butthey will most likely be contract-type jobsnot employees with full benefits, but certainly jobs

with a guaranteed pay check and regular income.

More important than the number, we feel, is the fact that a new skill category called retail jobs

will be created, and every bit ofjob movement up the value chain is welcome. Whats more, just

as NREGA improved wage rates across the board for labour in rural India by setting an

inflation-indexed official labour rate, perhaps the birth ofmodern retail will improve wage

rates in traditional retail as well.


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Will the small retailers, especially the kirana stores die?

The bulk ofthem are safe because they operate in small towns and rural India and serve the

lower social class customers as well.

In newer settlements, there are hardly any kiranas anyway, because the new real estate is too

expensive for them. It is inevitable that some will die, and already have, even as domesticmodern retail has expanded. However, there will be no mass murder. Many will survive, morph

and specialise. And most likely grow profitably from phone-in home delivery services, and e-

commerce, and most likely, will start managing the inventory in richer homes proactively.

#7: So what does all this mean?

Despite consumer demand and global retailer readiness, there are many reasons why the

investment in modern retail will be what we would describe as slow burn. Lack ofthe critical

ingredient ofreal estate is one big reason.

Then, there is the never ending political sabre-rattling around FDI; the possibility that different

states will impose different caveats; or that there will be new conditions that make the already

challenging path to profitability even more challenging. And finally, there is the structure of

consumer demand in India, which is inimical to modern retail.

Modern retail in India is not for the faint-hearted. The economics ofthe retail business in India

is severely challenging because ofthe structure ofdemand and the heterogeneity ofconsumer

preferences. There is less money in a given catchment area than in developed markets, because

the structure ofdemand in India is such that many people buy a little bit each and that adds up

to a lot. What works in retail instead is ifa few people buy a lot.

This is a problem for two reasons:

1. Sales per square foot2. Gross margin return on investment per square foot.

India scores poorly on both, also on account ofreal estate prices. Unfortunately, solving the

problem by going to far flung locations on the outskirts ofa city is not a viable option becausepublic transport is poor and fuel is expensive. The retailing model in America was built when

gasoline was cheap, and personal cars comprised the central nervous system ofthat country for

a long time. That is not the case here.

Another enemy retail faces is the heterogeneity in India. Every hundred-odd kilometres, there

are different oils, different pulses, different brands and different water conditions, to name just a

few. This makes scaling the business harder. As one retailer said, when we went from Chennai to

Pune, it was like going to another planet!


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The SKUs (stock keeping units, or items for sale) needed even for just cooking is a lot. In

markets with dismal mom-and-pop stores dominating retail, the consumer automatically runs

towards the organised retailer.

In India as we know, the so-called mom-and-pop retailer is a very savvy businessman, and has

customer relationship management skills and service levels that are very hard to beat. Ifvalue

is (benefit minus cost) as perceived by the consumer, then creating the value advantage overthe local small retailer costs money too.

This does not mean that there is no money to be made in organised retail in India. It just means

that it takes longer, needs harder work, and is not for the faint-hearted.

All ofthis will combine to dilute the actual investment to less than halfofwhat the market

opportunity can support today.

While this may seem like an opportunity lost, it also opens up the possibility that many local

businessmen will take a shot at entering the fray, learning this business with foreign partners,

and we may eventually see the emergence ofentirely homegrown retailers.

The other thing that is clear is this. Over the next five to 10 years, the strong foundations ofa

new industry with enormous potential will get put into place; new skilled and semi-skilled job

categories will be created; a set ofnew decent-sized supplier companies will emerge; huge joint

ventures will be forged; and a model for large corporate middlemen buying directly from

farmers and transmitting consumer preferences to them will be established.

So lets reality-check the wild hopes and discount the alarmism, and get on with the job ofbuilding one more good thing for the future. It will not be the cure for all ills, but it certainly is

one more remedy that needs to be given its best shot.

Rama Bijapurkar is an independent market strategy consultant; R Sriram is an entrepreneur

who co-foundedCrossword; S Raghunandhan has extensive operating experience in retail

andmalldevelopment businesses. They work together under the brandNext Practice Retail

to offer business design andconsulting services for retailoriented consumer businesses

forbes india magazine - decoding the detail in retail

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