Managing Director, IDFC SSKI Securities Ltd
Each square foot of retail needs Rs 2,000 of capital, organised retail makes a profit of just Rs 300! So who’s going to fund it?
With more than $300 billion of retail sales annually, an economy growing at seven per cent, 500 million people below the age of 24 who don’t have any guilt about consumption, I’m a big fan of organised Indian retail. But in the near future, organised retail’s story is a poor one. Superimposing a new channel in a non-differentiated business is always a long haul — even after being in the market for more than 15 years, some of India’s largest consumer companies like ITC, HUL, Nestle and the Tatas have got less than three per cent of the branded staples market. The same applies to all the attempts to digitalise the cable industry.
India is one of the most over-populated retail destinations in the world with one outlet for every 100 persons. Around 95 per cent of shopping is from the neighbourhood retailer who offers convenience, credit and personalised service — so why would consumers switch to modern formats which offer little differentiation in pricing (in the absence of scale or superior logistics) or location (convenience store formats like Subhiksha or Reliance Fresh are proving unviable)?
When there’s no major differentiation on offer, a ‘push’ strategy could help, of the sort DTH did with big subsidies — in 2008, the industry did 1.5 times what was achieved in five years. But the supply-side dynamics don’t quite favour organised retail. While inadequate investments on retail-ancillary and retail-logistics businesses curtail the ability to compete on pricing or product, poor economics of the existing operations and lack of investments in retail infrastructure will put the brakes on future growth plans. While the industry leader (Pantaloon Retail) is not adequately funded for growth, funded players like Reliance Retail/Tata and Birla have still to establish adequate scale to be competitive.
Since retail is all about logistics, the supply chain is critical as this is what allows retailers to extract that extra two to three rupees in low unit-price categories, especially agri-commodities. But investments in retail-ancillary and retail-logistics have been limited (barring Future Group and Reliance Retail). And the current scale of operations has not permitted players to scale up their private label portfolio (for higher margins).
All this has meant the economics of the industry have deteriorated. Every square foot of retail space calls for Rs 2,000-2,500 of capital, while the most profitable retailer generates Rs1,000-1,200 of cash profits at the store level, and Rs 300 at the net level. So, at best, internal accruals can support just 15 per cent of space addition. Given this, the fact that the books of rapidly-growing retailers are highly leveraged, and that the current environment is making access to external capital difficult, retail growth has hit a roadblock. Though there are capitalised players like Reliance, Tatas and Bharti operating in the space, retailing cannot exist in the absence of a retail environment — the competition also has to be funded.
The industry was anticipating over $20 billion of investments over the next five years. For the industry to sustain a 30 per cent growth would call for an addition of around 20 million square feet of retail space annually — that’s Rs 6,000 crore of annual investment on retail real estate development alone. With the real estate industry in a major cash crunch, this isn’t going to happen soon. The industry is scalable in the long run, but it will be a long haul. And the current turmoil puts a question mark on the survival of many of today’s industry leaders.
Managing Director, Subhiksha
We expanded without the expertise or supply chain. But costs are now getting realistic — so don’t be in a hurry to write us off
As we stand — in the eyes of many — on the verge of extinction, for me to dare to answer this question other than with a resounding ‘yeah’ would seem insane. While it is tempting to say yes, let us see the facts. There is this mess where nobody is making money — everyone is scaling back . Sales are down and everyone is worried about their very existence.
The problem is that Indian retail was doing too much, too soon. The kind of investments and expansion that Indian retail was attempting was unprecedented. We ourselves added 1,500-plus stores in under 24 months — even for a small store format, this would surely be a global record. Big players like Reliance and Birla were investing as if there was no tomorrow — the mirage of retail being the next telecom in respect of market capitalisation opportunity was so alluring that no investment was too large, and no loss was too big to take in the quest for size and scale. And most organised retailers had nothing but consultant reports to work on since none of them had any exposure to retail — and consultants could not figure what the issues peculiar to Indian retail were.
Retailers have two large costs — people and property. Both were hotter than an F1 car at the time when the fastest expansion in organised retail was happening. Retailers earn by squeezing the supply chain, but there was hardly any expertise in this. The vendors were far too smart to give away margins, especially in view of the puny size of most Indian retail. So, in effect, organised retail got jammed between the high costs — partly because of timing and partly because of over-anxiety — and the low incremental efficiency generated from the supply chain. It was no wonder that, for most new entrants, the expansion was a disaster waiting to happen. Some of the older retailers who avoided these mis-steps have been much better off — guys like us, of course, famously forgot to manage the balance sheet!
But the retail opportunity exists. People costs are beginning to get more realistic now, and with the demand-supply situation being what it is in the property market, we hope the insanity of the past will not be repeated in the near future. The lessons learnt have been scalding enough for most to ensure that the mistakes are not repeated again. Thankfully, most players have the persistence and interest to ensure they’re here for the long haul.
The current trough will be long, painful and tough, but this is also the best time for retailers to drive the deals they need with vendors to get the margins. Also, with a less frantic pace of expansion, there will be a greater focus on operational efficiency. India will always be a tough market for modern retail as the existing retail set-up is high on transactional service and very low on cost. There is no western model to beat this and that is where innovation will come into play.
The reality is that India-centric retail models have to develop — models that can not only deliver the business but, at the same time, also manage the balance sheet. Modern retail has not lost the plot — these are hiccups of over-speeding and I am sure the car will get back on track. No one can dispute the pain, but do not write us off.
In spite of the RBI's rate cut and the Centre's reforms, any recovery will only be half-hearted