Ride the tiger: India holds huge potent a for retailers, but there are pitfalls for the unwary

Financial Management (UK), July-August, 2008 by Tapan Jindal

As western markets become saturated, global retailers are seeing the developing world as the new frontier. India in particular has become a place to be: Marks and Spencer, Wal-Mart and Carrefour are joining domestic brands Reliance, Bharti Enterprises, Aditya Birla and Pantaloon in announcing ambitious expansion plans, indicating their intention to capitalise on the tremendous growth of its retail sector. But, as on any new frontier, many challenges accompany the potential gains.

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Organised retailing--ie, on a corporate scale--has grown significantly in India over the past three years and shopping malls have become common in cities. The grocery sector represents a huge opportunity, but firms will have to create a modern, efficient supply chain and overcome opposition from leftwing political parties and a powerful lobby of 13 million small traders. Hypermarkets will continue to be the dominant organised format, but smaller modern outlets need to proliferate if they are to compete with the ubiquitous neighbourhood kirana shops.

So why bother? The figures speak for themselves. India is the ninth-largest retail market in the world, with a total value of R14,500bn (173 [pounds sterling] bn)in 2007. It is expected to grow to 227 [pounds sterling] bn in 2010 and 323 [pounds sterling] bn in 2015. At present, organised retailing comprises only six per cent of the market (compared with 17 per cent in China and 85 per cent in the US), but its share is expected to rise to 15 per cent within two years. There are 1,500 supermarkets, 325 department stores and 300 malls under construction. Retail space increased from 22 million sq ft in 2002 to 101 million sq ft in 2007 and analysts expect it to exceed 300 million sq ft by 2012.

This growth is being driven by several factors. Demand is being fuelled by the country's huge middle class. The country has a large young working population, which is less burdened than previous generations with educating children and providing healthcare for elderly parents, while retirement is still a long way off. Meanwhile, India's economy is increasing rapidly: GDP growth was 9.3 per cent in the year ended March 31, 2007 and is expected to remain between 7.5 per cent and 9.5 per cent for the next few years.

Increasing urbanisation is also playing its part. The urban population, which was 17 per cent of India's total population in 1951, now comprises 29 per cent and is expected to reach 37 per cent by 2025. Personal finance is becoming more sophisticated and many more people now use credit cards and take out consumer loans. The proportion of women at work is rising, reaching 75 per cent in 2005, compared with 86 per cent in the UK. Their rising wealth is expected to lead to more spending in areas including home furnishings, jewellery and entertainment.

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The biggest challenge for companies hoping to cash in on this burgeoning market is the lack of retail space. Commercial property prices are soaring as demand outstrips supply. Other problems stem from the shortage of trained employees. The arrival of retail giants has sparked intense competition for talent, leading to salary increases for managers and reducing both profit margins and the ability of many companies to realise their expansion plans.

The supply chain is also a big issue. Most suppliers are small and struggle to provide the quantity of consistently high-quality goods and processes that large retailers need. A supplier that can provide this is in a strong position and can charge high prices. In addition, many Indian customers prefer not to buy their groceries in bulk. They don't expect to carry their purchases from the mall and they want free home delivery.

Organised retail expansion faces hostility from independent retailers, too. About 100,000 shop owners and street vendors protested in Mumbai late last year against the arrival of foreign firms such as Wal-Mart and German cash-and-carry specialist Metro. This was not an isolated incident: stores owned by Indian firms Reliance and Subhiksha have been vandalised in the eastern states of Orissa and Jharkhand. And in the southern province of Kerala the state government plans to restrict the number of outlets that large companies can open.

Legislation at national level creates further barriers for foreign companies. At the moment the Indian government allows 51 per cent foreign direct investment (FDI) in the retail sector to one-brand shops only. But it permits 100 per cent FDI in companies that engage in wholesale trading or cash-and-carry operations. This is why multinationals such as Wal-Mart, Metro and Carrefour are entering the country indirectly through such deals or via franchise agreements.

This contrasts with the situation in China, which first allowed 26 per cent FDI in its retail sector in 1992. This led to an increase in the top line from about 50 [pounds sterling] bn to more than 250 [pounds sterling] bn by 2002. Global retailers not only brought in huge funds, but also provided more modern technology and better employment opportunities. They also sourced most of their goods from local markets, which strengthened domestic manufacturing. In 2002 the Chinese government raised the FDI threshold to 49 per cent in 2002 and abolished limitations two years later.