A government has finally let in foreign retailers, but major players are still worried about their prospects. In conversations with the India representatives of global retail powerhouses, it is easy to detect a sense of indifference, if not despair.
But shouldn't these people be over the moon? The government has after all granted their wish and a long-pending one at that. Companies such as Wal-MartStores Inc, the world's biggest retailer, have long been lobbying to enter India.
Yet, it is obvious why retailers are not ecstatic. The government's welcome mat to multinational supermarkets is riddled with riders. Under the new rules, foreign multi-brand retailers must invest at least $100 million and half that amount must be ploughed into back-end infrastructure in rural areas.
That's not all. State governments will decide if they want foreign players and stores will be permitted only in cities of at least 1 million people. Retailers must also source 30% of the value of goods purchased from small- and mid-sized domestic suppliers.
Investments should not worry these deep-pocketed companies. Neither would a sluggish start. "I think it is a matter a time before states realise the commercial advantages and allow these companies," says Shushmul Maheshwari, CEO of research agency RNCOS. So the rub may well be the 30% sourcing diktat. Though it is not unusual of multinationals to rub shoulders with small players, they fear that procurement condition poses many difficulties.
The country head of a global luxury goods brand says in "our line of business craftsmanship and quality are top priorities". "The 30% condition restricts those priorities. We are not going to change our business model because we cannot compromise on our priorities," the official says, asking not to be named because she is not authorised to speak to the media.
Gunjan Gupta, creative director, Wrap, a luxury and lifestyle brand, says there is a huge cultural gap that has to be bridged in India. Gupta, a high-end crafts and furniture designer who works with traditional artisans and craftsmen, says the problem is that "our requirements are first world and their work is third word".
Quality apart, the actual sourcing itself could pose a hurdle to some companies, particularly single-brand retailers. Where and what will a French perfume maker procure from India?
No Other Option
Still, many analysts believe the government cannot be faulted for laying down tough conditions in light of the fierce political opposition that greeted the reforms. Fear of running into resistance had forced the government to pull out several similar initiatives in the past.
Footwear company Pavers England supports the 30% rule, perhaps the lone multinational player to do so. "India is not a manufacturing country like China. The Chinese invite to foreign retail was a boon because the companies were already sourcing majority of the products (sold) from the country and they invested money in improving infrastructure. The result was that the country used the resources and know-how of foreigner players," says Ravi K Mehrotra, chairman of Foresight Group, which has partnered Pavers to bring the brand to India.
Mehrotra says if the government permits 100% retail with no sourcing conditions (he wants the cap raised to 35%), the market will be flooded with foreign goods. "This will also reduce the local manufacturing base as foreign goods will be cheaper."
Authorities say the 30% clause accounted for these concerns. And now that the government has finally bit the bullet (of course, it had its back to the wall), foreign players were expected to play ball. But the response from retailers has been underwhelming, though these are early days.
Raj Jain, country head of Walmart, says local sourcing is manageable in the short term because it essentially involves setting up a business. "But as capacities increase in the long term, it is going to be a problem."
Furniture company IKEA's direct and indirect supply chain in India is made of small industries, but in the longer term, the mandatory sourcing remains a challenge, says spokeswoman Josefin Thorell. "For the IKEA Groupto secure low prices... small industries need to be allowed to grow and develop. To set up supplier know-how and capacity takes time."
IKEA has since demanded that the procurement requirement that calculates the total value of the goods purchased over a five-year average be relaxed to 10 years. "Compliance with the conditions over a cumulative period gives us time initially to develop these capacities," says Thorell.
But is the 30% rule such a big deal? At first glance, it is not. If retailers are worried that quality will be affected by procuring from "village and cottage industries, artisans and craftsmen, truth is most Indians are yet to make the leap from consumers to connoisseurs. Not when the price of goods and services trumps every other USP.
What's in Store?
More importantly, many foreign retailers are already sourcing from India. UK-based multi-brand retailer Tesco, for example, has been steadily increasing sourcing of garments along with other products from India. Tesco today sources goods worth £320 million from India compared with £230 million two years ago. The large chunk is still garments but it has bumped up the mixture to include kitchen and garden equipment, stationery and food items.
IKEA too sourced products worth nearly $450 million in 2011. The company is targeting sourcing in excess of $1 billion in the next few years, says the Thorell. But Arvind Singhal, chairman, Technopak Advisors, a consultancy, says it is fallacious to argue that just because retailers are sourcing from India, the 30% clause is easy to meet.
"A typical hypermarket of around 100,000 sq ft would be selling at least 40,000 stock-keeping units (toothpastes, brushes etc). There would be a few items of clothing that a retailer like Tesco would have sourced from India. Retailers hardly source hardware or food items from India," he says.
His argument holds true for IKEA too. A large part of the company's sourcing from India is made of textiles, rugs and handicrafts, but its mainstay is furniture. Singhal says the 30% rule is illogical and hasn't accounted for how the retail business is run. Few players would want to enter India because of this condition, according to him.
Miloš Ryba, senior retail analyst, Planet Retail, a London-based consultancy, says retailers seek strong partners with large production capacity (or good prospects to increase capacity) to produce not only for its operations in India, but also to export in the long term. But "cooperation with small local players will bring problems like low production capacity, inability of continual supply, low health and safety standards and out-of-date IT equipment. "All these factors will make the production costs and logistics very complex and expensive".
The 30% limit, he says, could also hurt imports. "Foreign retailers tend to import goods, especially private label products in the initial stage of expansion in a new market." It is only after they establish a partnership with local players that the situation could reverse and India becomes an important market and a key part of retailers' global sourcing, he says.
Until then, all foreign supermarkets will be affected by this rule, according to Ryba. He cites the example of Walmart in Mexico, which quickly expanded after FDI rules were abolished in the 1990s. Walmart invested in logistics and distribution. It introduced standard pallets, a rigorous delivery schedule into its distribution centres and computerised tracking which led to inventories on an individual store level.
To invest as much in India, Walmart would prefer large partners with strong brands (its existing partnership with Bharti Enterprises, a conglomerate that also owns Bharti AirtelBSE 1.62 %, India's leading telecom operator illustrates this strategy) rather than small local suppliers, says Ryba. "It would be too costly for Walmart to "educate or train" a large number of small suppliers, he adds.
It hasn't helped that the rule is ambiguous. A spokesman of a foreign multi-brand retailer said his company is unsure if the value of the goods sourced must be stacked against its global stores or just the Indian operations. "We are seeking legal opinion and waiting for more clarity before we proceed with our plans."
While India has kept the door ajar for foreign players, they have enjoyed a smoother entry in other growing markets. China and Brazil did not have major issues with the opening of retail markets to foreign retailers, says Ryba. "Governments understood their importance for its economy and opened smoothly their retail markets." Compared with the experience with those governments, foreign players might find India's attempts to embrace reforms as half-hearted.
The Real Dilemma
The biggest impediment is not the 30% sourcing itself but from MSMEs, says Singhal. "If companies were to source from anywhere in India, it would still be possible for them to operate."
Kumar Rajagopalan, CEO, Retailers Association of India, says the 30% sourcing rule definitely has good intentions. "But the need to source from the micro, medium and small enterprise [MSME] sector is limiting since the supplier could be a MSME player this year and may become a non-MSME going forward thanks to the size of orders requiring the business to invest more."
Even Pavers says the government must do away with MSME clause. Before starting its retail operations, Pavers established a design office and began manufacturing shoes at Visharam near Chennai. "The company can easily increase sourcing to 50% if the government removes the restrictions of small scale industry on manufacturing. If we move to large manufacturing, the tax structure on our factory will affect our costs," says Mehrotra.
He says the government should focus on employment rather than save small manufacturers as they have no incentive to improve products and increase capacity. Technopak's Singhal says a pragmatic retail policy would have allowed retailers to operate with the condition that they would have to export a share of the value of goods sold. He cites the example of PepsiCo in India, which had to export a substantial amount for every unit of beverage sold in India to enter India in 1989.
PepsiCo pioneered contract farming in India, where small farmers sell produce to multinational food companies at pre-determined rates and simultaneously access new sources of capital and technology. The conditions then looked tough for PepsiCo. But even after the rules were eased in the early 1990s, the company did not end its association with contract farming because it proved to be a win-win proposition. Today, the beverages and snacks powerhouse uses contract farming as a bulwark of its Indian operations rather than for exports.
Still Very Good
Singhal says he fails to understand why the same model cannot be replicated in retail. "Small enterprises producing intermediary goods and ancillary items will benefit." Does this mean most foreign retailers will stay away from India? Far from it. Notice what Walmart said a few days before the government announced reforms.
India offers great potential to Walmart as the country is "three times the population, one third the land mass" of the US, Scott Price, head of the retailer's Asia operations, told Bloomberg in an interview. No company, be it Walmart today, or PespiCo before it, cannot ignore India. Indians have more money than ever to spend and a good part goes into shopping for high-end watches, jewellery, liquor, cigars and cars (see Why They Will...). It shouldn't then come as a surprise that the $ 500-billion Indian retail industry is expected to grow to $ 1.3 trillion by 2020.
Despite the initial roadblocks, analysts believe that foreign players will devise ways to tap the market. Ankur Shiv Bhandari, MD and country head, Kanta Retail, a consultancy, says most retailers can squeeze value out of supply chains and back-end infrastructure, including eking out discounts from suppliers, reduce cost of logistics, staff costs etc. "If there is a desire, it could be made to work."
There is no shortage there. Companies continued to enter India even when the conditions were far more restrictive (see Still don't believe). Rising consumer confidence, consumption-based behaviour, increasing income, and a large pool of consumers provide opportunities for global retailers to invest in India, according to PwC.
Maheshwari says most international companies bring with them a strong financial muscle and a rich experience of operating in various markets. "They do understand that India is very different and would have to try various options to see which works best for them."
Wrap's Gupta says every export house in India catering to the high-end market is already working with small players, says. "It is not that it cannot be done." It might also turn out to be profitable. "Products which are already popular among Indian consumers and are sourced from Indian companies will definitely be favorable compared with foreign products," says Maheshwari.
In any case, with developed markets turning sluggish, emerging countries are fast becoming a retail magnet for foreign players. In the past five years, the revenues of Walmart, Tesco, Metro Group and other retail chain giants grew 2.5 times faster in emerging markets than in their home markets, according to PwC. All told, the 30% rule might not stand a chance against a 100% lucrative market.
But shouldn't these people be over the moon? The government has after all granted their wish and a long-pending one at that. Companies such as Wal-MartStores Inc, the world's biggest retailer, have long been lobbying to enter India.
Yet, it is obvious why retailers are not ecstatic. The government's welcome mat to multinational supermarkets is riddled with riders. Under the new rules, foreign multi-brand retailers must invest at least $100 million and half that amount must be ploughed into back-end infrastructure in rural areas.
That's not all. State governments will decide if they want foreign players and stores will be permitted only in cities of at least 1 million people. Retailers must also source 30% of the value of goods purchased from small- and mid-sized domestic suppliers.
Investments should not worry these deep-pocketed companies. Neither would a sluggish start. "I think it is a matter a time before states realise the commercial advantages and allow these companies," says Shushmul Maheshwari, CEO of research agency RNCOS. So the rub may well be the 30% sourcing diktat. Though it is not unusual of multinationals to rub shoulders with small players, they fear that procurement condition poses many difficulties.
The country head of a global luxury goods brand says in "our line of business craftsmanship and quality are top priorities". "The 30% condition restricts those priorities. We are not going to change our business model because we cannot compromise on our priorities," the official says, asking not to be named because she is not authorised to speak to the media.Gunjan Gupta, creative director, Wrap, a luxury and lifestyle brand, says there is a huge cultural gap that has to be bridged in India. Gupta, a high-end crafts and furniture designer who works with traditional artisans and craftsmen, says the problem is that "our requirements are first world and their work is third word".
Quality apart, the actual sourcing itself could pose a hurdle to some companies, particularly single-brand retailers. Where and what will a French perfume maker procure from India?
No Other Option
Still, many analysts believe the government cannot be faulted for laying down tough conditions in light of the fierce political opposition that greeted the reforms. Fear of running into resistance had forced the government to pull out several similar initiatives in the past.
Footwear company Pavers England supports the 30% rule, perhaps the lone multinational player to do so. "India is not a manufacturing country like China. The Chinese invite to foreign retail was a boon because the companies were already sourcing majority of the products (sold) from the country and they invested money in improving infrastructure. The result was that the country used the resources and know-how of foreigner players," says Ravi K Mehrotra, chairman of Foresight Group, which has partnered Pavers to bring the brand to India.
Mehrotra says if the government permits 100% retail with no sourcing conditions (he wants the cap raised to 35%), the market will be flooded with foreign goods. "This will also reduce the local manufacturing base as foreign goods will be cheaper."
Authorities say the 30% clause accounted for these concerns. And now that the government has finally bit the bullet (of course, it had its back to the wall), foreign players were expected to play ball. But the response from retailers has been underwhelming, though these are early days.
Raj Jain, country head of Walmart, says local sourcing is manageable in the short term because it essentially involves setting up a business. "But as capacities increase in the long term, it is going to be a problem."
Furniture company IKEA's direct and indirect supply chain in India is made of small industries, but in the longer term, the mandatory sourcing remains a challenge, says spokeswoman Josefin Thorell. "For the IKEA Groupto secure low prices... small industries need to be allowed to grow and develop. To set up supplier know-how and capacity takes time."
IKEA has since demanded that the procurement requirement that calculates the total value of the goods purchased over a five-year average be relaxed to 10 years. "Compliance with the conditions over a cumulative period gives us time initially to develop these capacities," says Thorell.
But is the 30% rule such a big deal? At first glance, it is not. If retailers are worried that quality will be affected by procuring from "village and cottage industries, artisans and craftsmen, truth is most Indians are yet to make the leap from consumers to connoisseurs. Not when the price of goods and services trumps every other USP.
What's in Store?
More importantly, many foreign retailers are already sourcing from India. UK-based multi-brand retailer Tesco, for example, has been steadily increasing sourcing of garments along with other products from India. Tesco today sources goods worth £320 million from India compared with £230 million two years ago. The large chunk is still garments but it has bumped up the mixture to include kitchen and garden equipment, stationery and food items.
IKEA too sourced products worth nearly $450 million in 2011. The company is targeting sourcing in excess of $1 billion in the next few years, says the Thorell. But Arvind Singhal, chairman, Technopak Advisors, a consultancy, says it is fallacious to argue that just because retailers are sourcing from India, the 30% clause is easy to meet.
"A typical hypermarket of around 100,000 sq ft would be selling at least 40,000 stock-keeping units (toothpastes, brushes etc). There would be a few items of clothing that a retailer like Tesco would have sourced from India. Retailers hardly source hardware or food items from India," he says.
His argument holds true for IKEA too. A large part of the company's sourcing from India is made of textiles, rugs and handicrafts, but its mainstay is furniture. Singhal says the 30% rule is illogical and hasn't accounted for how the retail business is run. Few players would want to enter India because of this condition, according to him.
Miloš Ryba, senior retail analyst, Planet Retail, a London-based consultancy, says retailers seek strong partners with large production capacity (or good prospects to increase capacity) to produce not only for its operations in India, but also to export in the long term. But "cooperation with small local players will bring problems like low production capacity, inability of continual supply, low health and safety standards and out-of-date IT equipment. "All these factors will make the production costs and logistics very complex and expensive".
The 30% limit, he says, could also hurt imports. "Foreign retailers tend to import goods, especially private label products in the initial stage of expansion in a new market." It is only after they establish a partnership with local players that the situation could reverse and India becomes an important market and a key part of retailers' global sourcing, he says.
Until then, all foreign supermarkets will be affected by this rule, according to Ryba. He cites the example of Walmart in Mexico, which quickly expanded after FDI rules were abolished in the 1990s. Walmart invested in logistics and distribution. It introduced standard pallets, a rigorous delivery schedule into its distribution centres and computerised tracking which led to inventories on an individual store level.
To invest as much in India, Walmart would prefer large partners with strong brands (its existing partnership with Bharti Enterprises, a conglomerate that also owns Bharti AirtelBSE 1.62 %, India's leading telecom operator illustrates this strategy) rather than small local suppliers, says Ryba. "It would be too costly for Walmart to "educate or train" a large number of small suppliers, he adds.
It hasn't helped that the rule is ambiguous. A spokesman of a foreign multi-brand retailer said his company is unsure if the value of the goods sourced must be stacked against its global stores or just the Indian operations. "We are seeking legal opinion and waiting for more clarity before we proceed with our plans."
While India has kept the door ajar for foreign players, they have enjoyed a smoother entry in other growing markets. China and Brazil did not have major issues with the opening of retail markets to foreign retailers, says Ryba. "Governments understood their importance for its economy and opened smoothly their retail markets." Compared with the experience with those governments, foreign players might find India's attempts to embrace reforms as half-hearted.
The Real Dilemma
The biggest impediment is not the 30% sourcing itself but from MSMEs, says Singhal. "If companies were to source from anywhere in India, it would still be possible for them to operate."
Kumar Rajagopalan, CEO, Retailers Association of India, says the 30% sourcing rule definitely has good intentions. "But the need to source from the micro, medium and small enterprise [MSME] sector is limiting since the supplier could be a MSME player this year and may become a non-MSME going forward thanks to the size of orders requiring the business to invest more."
Even Pavers says the government must do away with MSME clause. Before starting its retail operations, Pavers established a design office and began manufacturing shoes at Visharam near Chennai. "The company can easily increase sourcing to 50% if the government removes the restrictions of small scale industry on manufacturing. If we move to large manufacturing, the tax structure on our factory will affect our costs," says Mehrotra.
He says the government should focus on employment rather than save small manufacturers as they have no incentive to improve products and increase capacity. Technopak's Singhal says a pragmatic retail policy would have allowed retailers to operate with the condition that they would have to export a share of the value of goods sold. He cites the example of PepsiCo in India, which had to export a substantial amount for every unit of beverage sold in India to enter India in 1989.
PepsiCo pioneered contract farming in India, where small farmers sell produce to multinational food companies at pre-determined rates and simultaneously access new sources of capital and technology. The conditions then looked tough for PepsiCo. But even after the rules were eased in the early 1990s, the company did not end its association with contract farming because it proved to be a win-win proposition. Today, the beverages and snacks powerhouse uses contract farming as a bulwark of its Indian operations rather than for exports.
Still Very Good
Singhal says he fails to understand why the same model cannot be replicated in retail. "Small enterprises producing intermediary goods and ancillary items will benefit." Does this mean most foreign retailers will stay away from India? Far from it. Notice what Walmart said a few days before the government announced reforms.
India offers great potential to Walmart as the country is "three times the population, one third the land mass" of the US, Scott Price, head of the retailer's Asia operations, told Bloomberg in an interview. No company, be it Walmart today, or PespiCo before it, cannot ignore India. Indians have more money than ever to spend and a good part goes into shopping for high-end watches, jewellery, liquor, cigars and cars (see Why They Will...). It shouldn't then come as a surprise that the $ 500-billion Indian retail industry is expected to grow to $ 1.3 trillion by 2020.
Despite the initial roadblocks, analysts believe that foreign players will devise ways to tap the market. Ankur Shiv Bhandari, MD and country head, Kanta Retail, a consultancy, says most retailers can squeeze value out of supply chains and back-end infrastructure, including eking out discounts from suppliers, reduce cost of logistics, staff costs etc. "If there is a desire, it could be made to work."There is no shortage there. Companies continued to enter India even when the conditions were far more restrictive (see Still don't believe). Rising consumer confidence, consumption-based behaviour, increasing income, and a large pool of consumers provide opportunities for global retailers to invest in India, according to PwC.
Maheshwari says most international companies bring with them a strong financial muscle and a rich experience of operating in various markets. "They do understand that India is very different and would have to try various options to see which works best for them."
Wrap's Gupta says every export house in India catering to the high-end market is already working with small players, says. "It is not that it cannot be done." It might also turn out to be profitable. "Products which are already popular among Indian consumers and are sourced from Indian companies will definitely be favorable compared with foreign products," says Maheshwari.
In any case, with developed markets turning sluggish, emerging countries are fast becoming a retail magnet for foreign players. In the past five years, the revenues of Walmart, Tesco, Metro Group and other retail chain giants grew 2.5 times faster in emerging markets than in their home markets, according to PwC. All told, the 30% rule might not stand a chance against a 100% lucrative market.
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