India’s Retail Sector
Richard Dailly
For years rumors in the retail industry have predicted the imminent, complete opening of the Indian retail sector to non-Indian operators. Since the economic liberalization measures of 1990 were legislated, the amount of foreign direct investment (FDI) flowing into this sector, together with many others, such as banking, insurance, and print media, has been closely controlled by the Indian government. Partly as a result, India’s retail sector remains highly fragmented: 97 percent of the market belongs to unorganized outlets; just three percent to organized ones. India’s retail sector remains one of the few large unconsolidated markets in the world.
Change will not happen overnight. Echoing various previous statements of Indian policy makers, on August 15, 2009, India’s minister of state for commerce and industry, the governor of its central bank – the Reserve Bank of India – and the head of the government’s economic advisory council unanimously stated that there was “no proposal to implement full capital account convertibility.” Full capital account convertibility allows long term investors torepatriate all their profits, whereas partial capital account convertibility requires them to reinvest in the business a significant part of their profits. This ensures that a large part of foreign investment stays within India. Such a step strikes Indian policymakers as extreme towards opening up Indian markets.
Nevertheless, it is widely believed that the government is committed to increasing the amount of FDI in the retail sector, albeit incrementally. The government believes that the absorption of investment into the retail sector needs to be slow, in order not to dislocate existing family-run stores, but rather to create jobs for the children of these merchants. For the government, it is not a question of FDI versus no FDI; it is a question of big against small.
Investors bold enough to be first movers face daunting operational risks in an immature market including an inefficient and corrupted supply chain and logistics industry upon which it relies. Abundant but poorly written and enforced industry standards are cumbersome to comply with, dragging on efficiency. Suppliers are fragmented and susceptible to counterfeit product, stockouts, and quality inconsistencies.
One of the leading threats to retailers, of both Indian and mixed capital, is shrinkage. In more mature markets, shrinkage typically ranges from 1-2% of Cost of Goods Sold (COGS). In India, the metric is estimated to be much higher. Supply chains are not at the mercy of the inherent weaknesses of India’s infrastructure and distribution networks. They are also vulnerable to the officials who oversee infrastructure operations and to any other individual with whom goods come into contact. An example of this is the practice of transport companies that are hired because they have family links to the key official who controls the state border crossings. Kroll investigated one company who used this tactic to dramatically reduce the transit time from the south of India to Delhi – from three days to one and a half. Other sources of shrinkage include: short-weighing, pilferage, insecure vehicles, and poor product handling, all producing losses to be covered by the retailer.
Tracing shrinkage is an enormous challenge. Given that most transactions are still handled on paper-based systems, the audit trail for the movement of goods is often impossible to follow. Large retailers reveal that they have not been able to achieve any more success than their smaller competitors when it comes to combating shrinkage.
An important source of shrinkage originates from within the retailer, i.e. its employees. Amid widespread poverty, significant loyalty to a faceless corporation of apparently limitless wealth is unlikely. Countering this demographic reality are good practices that large retailers can employ such as background checks on all levels of staff and the construction of a strong, identifiable and magnanimous business culture.
Despite India’s reputation for churning out high caliber professionals, there is a shortage of managerial talent at the top of the Indian retail sector. Stories abound of unprofessional management, even among some of the biggest names in the country, probably because many major Indian retailers began as family businesses. Like many family run companies around the world, the prize C-suite positions in Indian retailers are reserved for family members and close friends. The absence of meritocracy prevents the hiring of experienced managers or the promotion of able mid-managers. The lack of professionalism, mixed with family politics leads to under-performance and unsupervised fraud and waste. One un-named Indian retailer revealed that they had not measured stock in several years.
As with every other Indian sector, any new retailer must navigate the maze of regulatory interference. Regulations require upwards of 30 license approvals, and any license approval in India is subject to abuse. At the political level, local strong-arm parties frequently demand employment for members. Large retailers entering the market would be perceived as a significant threat to the traditional way of life in some areas. This, combined with populist, aggressive political leaders and strong unionization, could provoke physical risks to high profile investors and managers.
In a world of modern retail, India stands out as one of the last great investment opportunities. The first investors will be attracted by the seemingly limitless opportunities. However, the risks they face, whether they are be they political, sectoral, physical, labor, or regulatory in nature, are equally daunting. Market entry must be carefully planned with a steady flow of business intelligence feeding the business decision process.
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