For last week since the Govt. of India decision, which was bolt from blue, to allow 51% FDI in multi-brand retail (100% in single brand) a sort of pandemonium is going in both parliament and media but for a disinterested (OK am interested in paying less for more goods :-) ) there is not much detail to go by especially since it was not preceded by any serious/analytical discourse in national media discussion are difficult to come by. In this space I have tried to address that lacuna without pronouncing on any judgment.
Retail Industry Landscape in India: Any mention of retail to us brings either the picture of neighborhood kirana store that we all have grown-up with or the vegetable vendors/hawkers on their carts or in a mandi. This memory accurately captures the majority of Indian retail experience untill circa 2000. Currently, Food & Beverages represents 70% of total retail trade by value and clothing forming the next segment at 10% whiles the rest being comprised of consumer durables, jewelry, personal care, footwear etc.
Except F&B all other categories have seen a strong growth of foreign owned players as these are mostly sold under single brand retail and have mushroomed substantially in last 5 years, only now new policy may allow likes of Macy’s or JC penny to open stores here but somehow that does not have emotional reaction like F&B.
The total size of retail industry is about $435 billion and accounts for about 15% of Indian GDP, and it employs about 40 million people either in retail or retail related logistics industry. In terms of comparison with others India retail labor productivity is 6% of US (thus could have huge savings but definitely with less no of jobs!) and has the world’s highest shopping density with 11 shops/person but with least space per capita (only 2 sqft/capita).Thus this is definitely fragmented and in-efficient industry which definitely needs to be turned around but would involve massive change as it touches directly/indirectly with huge population across India.
Traditional Retail: Traditional Trade is defined as all that trade that flows through outlets such as kiosks (Pan-wallahs, imagine what will ITC and Telecom service provider do without them!), Kirana shops (local mom and pop shops), open markets (Mandi), hawkers/street vendors etc. It represents all trade with the exception of that which flows through retail chains, supermarkets, or super stores a.k.a. Modern Retail.
Traditional Retail used to be the only retail channel until the last century all over India but in last decade with arrival of Modern Retail in urban India its percentage share is now about 93% of total trade. In terms of distribution 24% of retail trade occurs in cities with more than 1 million populations i.e. the ones where foreign owned corporations will be currently allowed in to open shop.
Challenges for Indian Retail Industry:
1. Supply Chain: is a key area where substantial improvement needs to be achieved for Indian retailer to achieve close to Int’l norms in terms of efficiency and productivity. This is one issue where India will need to address core infrastructure if at all it wishes to benfit from retail modernization. The core issues here are:
· Transport Infrastructure: India lags in rail, road and port development compared to its peer in BRIC countries. This would mean Govt has to take the initiative in developing port and rail network especially rail where freight will need to be accorded higher investment as it is a profitable sector on its own. Will require a consolidated trucking industry from the current fragmented one.
· National Cold Chain: No reliable cold chain network which causes huge food wastages, 40% is the wastage for highly perishable items the figures are mind boggling upwards of Rs 60,000 crores, criminal in a country with army of under-nourished children.
· Lack of countrywide distribution network: This causes each product company to manage their own distribution with emphasis on urban areas due to high density and higher spending power. This results in maintenance of high inventory at retailer shops which result in higher cost to end consumer.
Supply Chain issue will need to be addressed on high priority and may require common industry based solution as each retailer cannot develop this whole infrastructure on their own, for e.g. they can follow Telecom service providers who share tower infrastructure but compete on services.
2. Infrastructure: To develop and maintain complete retail and logistical infrastructure would require reliable Power, water, communication infrastructure to support the growth projection.
3. Land Use/Real Estate policy: India will need to sort out the mess that surrounds real-estate/zoning laws (look at ULCA and stamp duty). This is especially true in urban areas where large land required to support such Big-box retailing is non-existent or if available then at very high rentals which in turn means high costs to end customer. It will also need to have proper urban planning (am asking for moon!) to ensure that there is enough space to support customer transportation. If properly managed this could be a huge opportunity for construction industry (current projections have unmet demand of 500 mn sqft?? need to validate)
4. Taxation & Govt Policy (APMC): Tax structures need to be standardized in terms of process (states can still have different level of taxation) and octroi and entry tax needs to be abolished as they are a major source of corruption and delays in goods movement. Indian states will need to modify their APMC acts so as to enable free movement of goods and enable direct purchase from farmers without a huge chain of middle-men. This should help Govt in the long run as it will majority of transaction will be on the accounting books of retailer (modern retailers escape tax by employing highly paid CAs!)
5. Sourcing from Producers: This is one area where there could be huge impact, Indian farmers are fragmented lot and majority of them do subsistence farming with very small land holdings. Thus in supplier – producer relationship they will not be in a position to bargain against a deep pocketed customer , also from buyer’s perspective managing so many supplier and their relationship will be a night-mare but this could be managed by forming local co-operatives. India already have some experience in this due to now presence of food processing industry. The additional benefit is that it should result in lot of agro based industries in rural areas providing employment opportunities. Another bone of contention will be on the clause which requires them to source 30% of their supplies from SSI (Small scale Industry) in India. This is a policy for which we can state “Road to hell is paved with good intention” as this was meant for saving indigenous handicraft and cottage industry but now is an inefficient legacy of past as it obstruct in achieving economies of scale.
6. Misc: Some other issues faced by industry are
· Lack of skilled resource as India currently do not have specific courses for retail management that can meet the projected demand
· Labour laws to allow flexible working to support 24x7x365 kind of operations
· No customer spending patterns, country-wide or region wide
· Large grey market
If and when these changes are implemented it is expected to raise the CAGR from current trend of 7-8% to 11-12% for long term i.e. for next 20 years which will have a significant impact on Indian GDP growth rates probably pushing it above double digit growths
Case study of China Retail Industry: China before modernization had a very similar industry structure like India i.e. it’s economy was pre-dominantly rural with very large no of small retail shops spread across multiple markets with their own distinct preferences and practices.
It started modernization of its retail industry in 1989 when it opened up Beijing and Shanghai for foreign retail corporation at that time total retail market was $100 bn. From that moment on it has been modernizing and opening up to FDI its retail industry consistently
· 1993: FDI allowed in 11 cities through JV with maximum FDI of 26%
· 1999: Provincial capitals opened up for with FDI limit of 49%
· 2003: FDI to go over 50% i.e. majority stake
· 2005: 100% FDI with all major restrictions (like urban/rural etc) removed; Retail Sales is $500 bn even at this juncture the modern organized retail only accounted for 20% of the overall market
· 2012(E): Retail sales are expected to be around $2.1 trillion and this will be the second biggest market after US
The key feature of China markets is
· Top 20 retailers have a market share of 8.9%
· Majority of top retailers are Chinese; they comprise 8 of the top ten and eighty of the top 100 retailers
· E-commerce penetration rate is 20% as oppose to approx 70% in US & Japan.
· Online commerce CAGR of 105% from 2004 to 2010
· Most M&A remains between domestic companies
· Emerging Chinese retailers looking to increase overseas activities and compete in Global markets
· Many of the western retailers have closed Chinese operations as they could not cater to Chinese needs (Mattel) or their operating model was too westernized (Best Buy)
To sum it up would like to quote AT Kearney 2011 GRDI report “While Chinese retail market will hold substantial promise for years to come, achieving profitability in the market is not easy. Success will not happen overnight, or without putting the right mechanisms in place to ensure consumer acceptance. Also, success in China means doing business the ‘Chinese way’ – simply cutting and pasting your existing operating model won’t fly.”
The billion dollar question crucial question which I have not addressed yet is how does it impact to 40 million persons associated in retail mostly in traditional format? Do they just fold away and disappear into a black hole on appearance of modern retail? Will farmers be like slave laborers of big corporation with no power in pricing, crop or seed negotiations? What will be the fate of trading community that is involve in multiple level linking producers to retailers?
In light of our Indian experience so far it is clear that Modern Retail has not been able to change retail landscape dramatically as in our metros we continue to see the presence of both form of retail continuing to co-exist where customers have clear preference for local stores for fresh produce and small everyday item while they shop in modern stores for expensive goods such as consumer durables, watches, clothes etc. While modern outlets are preferred for better product quality, fresh stock, exclusive designs, more variety and better customer service, traditional outlets have the advantages of proximity, lower price and convenience.
Impact on various actors in Retail
Retailers: Initially, market is being opened up for in big urban areas where Indian modern retail is already present and co-existing with traditional shops. There is unlikely to be growth for traditional retail but they will definitely be around for decade or two or longer especially in fresh produce, secondly they will continue to serve low-income household due to their ability to provide short term credit which no modern retailer could provide. Do not expect too many reductions in job but growth will be flat in urban areas.
Traders (Distributors/Whole-salers/Sub-distributors): this is the group (in urban areas to begin with) that will bear most of the impact as modern retailers would not like to pay for middleman who is not providing any value add in supply chain. The niche players may survive as that relationship and produce might be difficult to replicate by Modern retailers. The biggest road-block (from retailer perspective) is the abolishing of APMC act by individual states and allowing for contract farming. This would be major impact on those households that are dependent on this as their income, it is easy to caricature them as good for nothing but most of them are from middle income group and could easily face tough times (India does not have any social welfare). In my opinion Govt will need to provide a way out where these could be provided training so they can be re-employed gainfully.
Farmers/Producers: This group is likely to gain in overall terms as in general they will receive higher prices for crops, could move into higher margin cash crops and in total sales due to lower wastage due to cold storage facilities..It should potentially see lower employment due to consolidation and higher mechanization but that should be made up due to new opportunities in value added agro-industries. This has already happened to large extent in better managed states like Punjab, Haryana and Maharashtra due to growth of agro-industries in last two decades and lesson learnt from these areas could be used elsewhere.
Conclusion: We have clear two disparate scenarios where in one India continues the existing way in retail to support its growing and demanding population with the same in-efficiencies, wastages in supply chain resulting in huge demand on producers resulting in side-effects like high inflation and huge and unmanageable demand on land. The second scenario is where we modernize each of the economic activity in this chain from production so that the gain made in this process could be shared by each actors i.e. farmers having a higher prices, retailer a bigger market share, and consumer more choices at competitive prices.
I guess the answer is likely to be a no-brainer but we will be fooling ourselves if we do not realize that this will be major change for a lot of people and they will need support of society in different ways to cope with it. The good part is that this change is not happening over-night but spread over a period of decade.
Why FDI?
I have discussed and compared traditional v/s modern retail but someone could argue that why can’t we have wholly Indian owned modern retail and achieve the same goal that have been set before us?
It is a nice question for the argument sake but on looking in detail it is quite clear that India does not have skill and experience in building a modern retail and that includes the know-how in building and operating logistic business, merchandizing, customer insights etc. If we look at business history not nation has acquired any expertise in isolation it has always involved sharing where existing player bring business and technical know-how while the recipient provides local business processes and flavors and both needs to be fused successfully. Hence, in my post above have assumed this to be the case for above.
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