Back to basics
The next phase of growth for organised retail is expected to be more gradual. It is imperative that retailers take a cue from their mistakes and transform some key aspects governing retail activity
Currently valued at about $350 billion, the Indian retail sector has been growing at over 10 per cent for the past three to five years and has been one of the prime drivers of growth in the Indian economy. Retail is one of the largest sectors of the Indian economy and contributes to about 10 per cent to India’s GDP. It has propelled several domestic and international companies to invest in India’s growth story owing to its potential.
However, during the economic slowdown, retailers were forced to shift focus from business expansion to rationalising and optimising operations. While this improved their cost performance, business performance was impacted due to slowing down in their expansion plans.
| BIGGER IS BETTER |
| * Increase in store size allows more categories and increases average ticket size |
| * It also allows higher penetration of margin driver categories and pushes up average gross margins |
| * Fixed costs increase at a rate lower than sales increase thereby reducing per sq ft costs |
| * Overall increase in store EBIDTA due to sales increase, gross margin improvement and reduction in fixed costs |
To assess the state of organised retail in India, we reflect back to the industry trends and the possible future course of the industry.
Build up to the slowdown
The initial phase of growth in the Indian retail industry was marked by a rush for retail space and a scramble by companies to gain a first mover advantage. Coupled with bullish economic prospects and the anticipation of a quick change in consumer preferences, organised retail activity grew quickly in the periods between 2005 and 2008.
However, the organised retail sector had not taken into account the possibility of a sudden drop in consumer sentiment, fuelled by the global economic slowdown in 2008-09. This along with unviable contracts with allied sectors exposed retailers to inefficiencies in strategy and operational planning. During the year, more than 2,300 retail stores (more than 4 million square feet of retail space) were closed or relocated due to below expected performance. Given the impact of this downsizing exercise, most retailers were forced to shift focus from business expansion to rationalising and optimising operations of existing stores. While the impact was discomforting, a reality check was essential, and better earlier than late.
The outlook turned positive again in 2010 with the shoppers returning back to high-streets. Now, retailers were better geared to cater to customer requirements and manage costs effectively at their end. This is reflected in the robust revenue growth of 30 per cent and ‘like to like’ growth of 15-25 per cent for most organised retailers. Moreover, for the same period, most organised retailers have been able to improve margins as well.
However, what has emerged clearly is that retail is a story of growth and scale. Building a cost-effective model is one thing but building an efficient business requires scale and investment for the long term.
Focus on basics
With prospects for the Indian economy improving further in 2011, the next phase of growth for organised retail is expected to be more gradual. Companies are expected have a dual agenda with equal focus on store expansion and fine-tuning strategic and operational metrics to grow sustainably. It is imperative that retailers take a cue from their past mistakes and transform some of the key aspects governing retail activity to ensure future sustainability. Multiple strategic and operational shifts have been observed in this regard.
- Aligning with the Indian environment: While the initial choice of store formats and location was determined by availability of real estate, going forward, organised retailers are expected to rationalise store expansion plans, focusing on a few key store formats at critical locations which may provide profitable growth. Moreover, for a retailer, India is sum of several countries, where activities such as merchandising and branding need to be looked at a store/regional level.
- Focus on big retail: Organised retailers have realised that the cost of servicing smaller stores (typically less than 3,000 sq ft) is higher and that both scale and a high degree of operational efficiency is required to make them profitable. Larger stores give the retailers an opportunity to bring in more categories and drive higher margins through a change in category mix. The accompanying table shows that larger store sizes could be more commercially viable than smaller stores in the Indian context.
- Shifting focus to lucrative tier II and III cities for store expansion: The broad-based consumption growth occurring across urban agglomerations in the country has created new markets for organised retail beyond the metros and tier I cities. Added to the socio-economic changes, a spike has been observed in the availability of real estate for organised retail usage in tier II and tier III cities and towns, at rates substantially lower than the top cities.
Although the focus has shifted to these smaller cities and towns, organised retailers are treading cautiously. They are testing and revising their formats and concepts before expansion.
| CRITICAL ELEMENTS OF STORE PROFIT AND LOSS STATEMENT | |||||
| Elements | Figures in Rs | Actuals in Rs /month | Ratio of increase | ||
| Average store size | 2,500 | ||||
tickets/day
However, taking into consideration the lack of local market knowledge and operating challenges in servicing these markets, several brand owners and retailers have resorted to third-party retailing models such as franchising. Retailers today are actively scouting for locations in these cities to leverage their brand, gain a first mover advantage and satisfy the pent of demand of consumers there.
- Increasing visibility to improve decision-making ability: Diversity in consumer preferences necessitates that retailers would require timely and accurate reach to critical decision-making variables. Thus, retailers in India are increasingly investing in creating an information strategy, incorporating data capture, analysis and decision making within its fold. As their size grows, the focus on system-based decision making, auto replenishment and so on will only gain more focus.
- Leveraging private labels as a key growth driver: Private labels today account for less than 5 per cent of a retailer’s revenues in most segments. Private labels offer a good way to improve margins as well as manage the brands. Most retailers will increase their focus in this segment, emphasising on sourcing and vendor partnerships, product quality and consistency as well as in-store activation. Private labels have been a key driver of growth and consumption for them. Several foreign economies and Indian retailers are hopeful of increasing the penetration of private labels on the back of better pricing and merchandising.
Going forward
Going forward, the Indian retail sector is expected to regain momentum and is poised to grow at over 13 per cent a year to reach a size of about $600 billion by 2014. However, driven by an increase in penetration, the organised segment is expected to clock a higher growth of about 20-25 per cent in the same period.
The author is partner and national leader, retail and consumer product practice, Ernst & Young