The Indian Retail Landscape: Now and Beyond

Reasons to be Cautiously Optimistic Phase of Rebuilding Begins FDI Relaxation at Inflection Point Cascading Impact of Modern Trade Early Onset of the Turf War Real Estate - Absolute Shift of Power Supply Chain to Get its Due Consideration Marketing Spends to Get Realigned Retail HR - Reduction in Costs and Balance Struck in Expat Recruitment 15 16 18 19 20 22 24 25

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Reasons to be Cautiously Optimistic

The year 2008 witnessed economies becoming sluggish, stock markets crashing, banks going bust and falling consumer confidence all over the world. India has also been adversely affected. However, the Indian growth story is driven by strong fundamentals. Hence, even in the relatively lower GDP growth scenario (projected downwards from 8% to 6.5%), the Indian growth promise remains intact. Despite the turbulent times, sectors such as FMCG, Consumer Durables and Rural Economy have done reasonably well. Infact, some of the sectors have seen unprecedented growth in the wake of softening commodity prices and recent excise duty cuts. Input costs have dropped by roughly 25% to 30% in several categories. Inflationary pressures have eased and the interest rates are projected to head downwards. Hence, the Great Indian Retail story is still intact and will continue to witness evolutionary growth and opportunities in the years to follow albeit with some shortterm hiccups. It can also be argued that the current turbulence is something not completely undesirable. It has been a reality check for retailers to take stock of their operations and strategy. This will make them go through a sanitisation phase of restructuring, reconfiguration, re-planning and renegotiation towards robust & efficient business models leading to stronger proposition and long term sustainability. Technopak expects the best phase in Indian retail sector is yet to come in the next five years, when the sector would see major expansion by national & international players, consolidation and operational efficiencies would set in. In this document, we have tried to capture a few trends in the Indian retail landscape. These reflect the future of Indian retail and the picture as we see it, continues to be promising.

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Phase of Rebuilding Begins

01

Modern retail in India has been going through a steep learning curve. The first phase of setting shop is now over and it has entered a new phase where retailers are taking a hard look at their fundamentals. The last few years have seen players experimenting with formats, product mix, locations, sizes, customers and now is the time when we expect the phase of rebuilding would begin. The key areas of rebuilding would include: Re-Sizing and Relocation With recent drop in rentals, many leading retailers are in the process of re-negotiating rentals with the developers. They are also planning to relocate stores which are economically not viable or where rentals are more than market rates and resizing others to make them more profitable. Retailers are identifying stores to find out opportunities for resizing, closure or relocation. Resizing would be a major phenomenon with the big formats getting even bigger. Larger stores would enable the retailers to offer more variety to the consumer and meet all consumer needs with All Under One Roof proposition, thus capturing a bigger chunk of consumer wallet and larger consumer base This will also enable retailers to realize higher margins by adding more non-food & grocery (F&G) lines since F&G is essentially a low margin category This will further enable cross-subsidization of essential items for which the consumer price sensitivity is high At the same time smaller formats may further get smaller in order to get closer to the customer and offer greater convenience. New Formats Most of the players are operating across multiple formats. We have seen a rapid scale-up of operations by older players and new entrants and expansion into specialty formats along with the core F&G. Retailers are experimenting with new formats in order to hit the right formula as well as to target a larger share of consumer wallet. Future Group had 4 formats in 2003 and now it has more than16 formats. Reliance also has more than 12 formats. Reaching to New Consumers With a presence in top 70 to 80 cities, modern retail is still currently under- penetrated and actually serves 7% to 8% of the total Indian population. Retailers are moving to a larger consumer base with focus shifting from upper income consumers to middle class, and finally into the markets of the urban poor/rural market. Lower income segment is being targeted by a different value proposition of products/ prices/ services such as deep discount, private labels.

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Spreading to New Geographies Though most retailers initial focus has been on metros and mini-metros, they are rapidly moving into smaller towns and even rural India. This is because metros have already witnessed 15% to 25%+ penetration of modern retail (compared to 4% to 5% at all India level) and all the attention and investments are already leading to: Cost escalation - real estate, services, people Margin dilution - due to competition, market share wars Cannibalization - over saturation of certain locations So while retailers are not ignoring these thriving markets, they realize that they need to look beyond metros and larger cities now to achieve ambitious growth. It is expected that by 2013, modern retail would have reached at least top-600 Indian cities and towns, and perhaps directly or indirectly will have access to over top 50,000 villages e.g. from 5 cities in 2003, Koutons is present in more than 250 cities now. Vishal Megamart is present in more than 100 cities, Big Bazaar in more than 60 and Caf Coffee Day in more than 200 cities. Restructuring of Operations Last few years witnessed frenzied activity in terms of store opening and this led to a lot of inefficiency creeping in the operations of the company. Slowdown has given an opportunity for retailers to streamline their operations. A number of retailers are restructuring their operations through combining the operations of various formats to reduce overheads and achieve economies of scale. In addition, retailers are also restructuring their supply chain by reducing inventory and logistics costs to reduce working capital requirements.

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FDI Relaxation at Inflection Point

02
Phase 2 Players will ramp up rapidly after gaining knowledge, some categories might see opening of FDI Phase 3 FDI may open in retail, all major international players will set up base in India

India is today the only major economy that still does not permit FDI in retail trade. Currently, the Government policy allows up to 51% FDI in single-brand retailing, and 100% FDI in cash-and-carry wholesale trading. FDI in retail is not allowed in multi brand retailing.
Exhibit 1:

25% Modern Retail Penetration (%) 20% 15% 10% 5% 0%

Phase1 Growth rate stemmed by cautious approach, limited FDI allowance etc.

2007

2008

2009

2010

2011

2012

2013

2018

* All figures in percentage

One of the major reasons for indecision in opening up FDI in retail has been the fear of its adverse effect on the small retailers. Also, the political repercussions of this decision has made the government overcautious in its approach. However, the need for relaxing the FDI norms now is more than ever before. In order for GDP in India to grow at a level of 7% to 8% in this current global slowdown scenario, it requires raising the rate of investment as well as generating demand for the increased goods and services produced. FDI will lead to increase in exports due to high level of sourcing from India, technological and processing capabilities, infrastructural developments, increased employment, and inflow of funds and investment in the country. Hence, FDI can catalyze the retail boom and provide an upward push to the overall economic growth of the country. Given the need of the hour, we may see an overall easing out of FDI norms once the new government takes over. However, FDI will still be eased in a phased manner with Food & Grocery (F&G) being last of the categories to be relaxed. Ahead of Commonwealth Games 2010, the Government may want to meet the arising demand in sports and electronic goods by facilitating foreign companies to make direct investment. Also, it may ease out relatively less-sensitive sectors like apparel, lifestyle products, house ware, and entertainment etc. over the next few quarters.

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Cascading Impact of Modern Trade

03
Exhibit 3:

The consumer shopping behavior has undergone an evolutionary change with the advent of modern retail. With increasing exposure, the consumer of today is getting comfortable with modern format and also more experimental than in the past. Modern format stores provide conducive environment for the consumer to become more involved in the product selection and up-gradation.
Exhibit 2:

Shopper Habits for a Consumer Goods Category What is the shopper looking for? Traditional Retail Modern Retail 100% 80% 60% 40% 20% 0% Variants offered by brand Promotions Price

Shopper Habits for a Consumer Goods Category What is the shopper looking for? Modern Retail Traditional Retail

100% 80% 60% 40% 20% 0% Upgradation

45% 55%

35%

65%

Same Brands

New Brands
Source Technopak Research

Source Technopak Research

The plethora of brands available in a modern format store forces a shopper to spend more time in comparing the benefits, cost and finding the best that suits his/her needs. Even if the shopper has a brand in mind he/she looks for new opportunities and products that may add to his satisfaction. Such stores provide an environment where the shopper likes to spend more time and choose his/ her basket of products. As a result of more exposure and time spent, consumers are trying new brands and variants while shopping in modern format stores. Almost half the time they end up buying new brands or variants for many categories.
Exhibit 4:

Shopper Habits for a Consumer Goods Category What is the time taken to decide brand / variant to purchase? 80%

35%

50%
17%

15%

This has a cascading impact on the type of products <2 Minutes <2-5 Minutes >5 Minutes and promotions of consumer product companies. Modern Retail Traditional Retail Source Technopak Research Consumer product companies have understood the shopper trends in modern retail and are adding high variants to their modern retail portfolio to lure the consumers. Companies are also able to launch high end products through modern retail and can find market for several niche variants which they were unable to promote through traditional retail stores, where space and ambience are serious constraints. For example, Dabur India launched a 400 gram squeeze pack of Dabur Honey only through modern format stores. Later, the company also launched two variants of Chyawanprash, a sugar-free version and another that claims to combat stress, both in modern format stores where the target customer is likely to shop and, perhaps more importantly, is willing to pay a premium that products charge over regular variants.

0%

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Early Onset of the Turf War

04

The growth of modern retail has posed a different challenge to consumer product companies. The availability of the manufacturers/vendors and the hindsight learnings have led to the early onset of turf war between the consumer product companies and retailers. The realization is fast dawning upon several consumer product companies that the rules of modern retail are different from traditional retail and success in one does not guarantee success in the other. There are several examples where industry leaders enjoying the lions share of traditional trade are reduced to minority players in modern retail. For example one of the leading Consumer Durables & IT (CDIT) company with more than 15% share of traditional market has only 7% to 8% share of CDIT sales from modern trade which would become a cause of concern in future as modern trade grows bigger in value and volume. Many consumer product companies are unable to get similar success across both traditional and modern trade due to their same size for all attitude, even though the channels are very different from each other. These differences include: The consumer behavior across both channels is very different. Modern trade provides an environment where shopper spends more time in choosing the products. They compare different brands, variants before making the final purchase decision and hence are highly involved. They end up trying new brands and variants while shopping in modern format stores. Most modern retailers prefer a Terms of Trade (TOT) document that defines the relationship between the two parties. The key challenge for suppliers is to prevent margin dilution with the increasing power of retailers. Very large retailers may have to be treated as key accounts and suppliers may have to come up with innovative schemes such asco-branding, exclusive promotions to maintain a win-win relationship. Organization structure for modern retail needs to be different. Modern retail needs a structure that provides stability in a dynamic environment and offers flexibility to prepare for the high volume business. Parameters like category management and new product launches, which were not so important in traditional retail gain importance in modern trade. Modern retailers use parameters like fill rate, category management, margins, organization commitment, new product launches etc to evaluate the suppliers.

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Additionally, the increasing penetration of private labels of retailers dilutes the bargaining power of the consumer product companies. Indian consumers are willing to spend money, yet they are value conscious. Private labels, on an average, offer price discount of 15% to 30% versus their branded counterparts and therefore, have brought new customers and lead to increased consumption. Given that the sale of every private label item replaces the sale of a potential branded item are getting more empowered retailers and getting better margins. It also gives retailers more negotiating power in the product category. For these reasons, retailers are also promoting regional and smaller brands. Juice, for example, is a category where almost 30% market has been taken up by the relatively unknown brands/private labels. In the long run, private labels can also help differentiate one retailer from others and can be used to build store loyalty. Since private labels play a crucial role in the power shift from brand manufacturers to retailers, all major retailers would sooner or later focus on it. Given the challenges, we will witness evolution and differentiation of channel strategies of consumer product companies as modern trade grows. Technopaks interaction with some of the leading consumer products and consumer durable companies has revealed that the companies are getting ready in terms of redesigning their service models, organization and processes to meet the expected demand from modern retail. Many of them are beginning to understand the so far neglected area of shopping behaviour. Branded outlets are rediscovering themselves (e.g. Sony, Canon etc) to create the preferred outlet for brand communication and also stand in good position while dealing with the retailers. Consumer product companies are also trying to protect their turf by investing in traditional retail channels and upgrading them to maintain their stronghold. Large players are partnering with local vendors to revamp and modernize their retail outlets and upgrade the overall retail environment. HLL Super Value Stores, and Marico Mera Bazaar have undergone this transformation.

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Real Estate Absolute Shift of Power

Evolving Relationship of Developer - Retailer
Sale Model
Shops sold to retailers/investors Short term investment Lack of discipline, maintenance & control over trade and tenant mix, high vacancy rates Medium term investment (Low-risk/medium returns) Some control over mix & therefore, the shopper Some ability / flexibility & incentive to improve

05
Risk Share Model
Retailers and mall owners get into an agreement where in they work together right from the beginning, from the design stage of the mall to when operations begin and further, sharing the risk at every stage Globally, risk-sharing models already exist. In several instances, giant retailers such as Wal-Mart have even gone in for a 20% ownership to de-risk the business for the landowner and also have a greater participation in design and development of the property

The first two quarters of 2008 witnessed a steep escalation in real estate prices especially mall and high street rentals that retailers started pulling out of malls or delaying their expansion plans than operating unprofitably. As a result, several malls could not get full occupancy thus, adversely affecting footfalls.

Lease / License Model

Revenue from rent Lesser Risk

Revenue Share Model

Base rent or percentage of sale, whichever is higher Business partnership between retailer & developer Incentive to build a better product Result oriented events and promotions, retailer and developer jointly drive promotions to generate footfall in the malls Better equipped to face competition Same risk profile but great returns

The third quarter of 2008 brought some correction in real estate prices. With inflationary trends, high operating costs and low footfalls, major metros started witnessing a dip in rentals. The fourth quarter of 2008 witnessed more corrections and further drops. Most of the markets have witnessed a correction of 15% to 40% in rentals. Rentals in many malls have witnessed renegotiations and corrections. As a result, the developers are on their back foot. They have begun to realize that their role needs to extend beyond mall construction and cover mall management as well. Both retailers and mall developers have realized the need of collaborative models to create a win-win situation for the retailer, mall developer as well as the consumer. Retailers cannot afford rentals more than a percentage of sales on an average across categories and developers need a minimum return over inflation rate or base lending rate to justify the investment. Therefore, the need for a model based on minimum guarantee or revenue share, whichever is higher, works well for both the parties, and hence we see the increasing adoption of revenue sharing model. Revenue sharing that implies mall developers need

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to create ways to attract footfalls and retailer revenues and not abandon the mall once leased out. Since mall quality has not been a focus for most developers in the past, a large chunk of retail space would be untenable due to poor quality or location. Therefore, the next few months will see the retailers choosing reliable developers and selection of location would be very critical. Cases of better quality malls in same area commanding higher rentals are a testimony to the importance of mall quality. Mall management has been a major challenge for Indias developers, who until recently have mostly developed properties and then sold it to investors who further lease it out to the retailers. This has resulted in unplanned and uncontrolled developments of the malls and may lead to eventual loss of rental values. Given the increasing competitiveness, developers need to focus on mall management aspects such as location, research on catchment area analysis, right mix of component and tenants and right zoning. Hence, mall developers are also getting serious. They have increased focus on tie-ups, better quality malls, innovation, mall development and management. Technopak also expects that given the financial difficulties faced by mall developers, there would be a significant delay/postponement in a number of planned malls thus leading to shift of retailers to high street locations.

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Supply Chain to Get its Due Consideration

06

Till date, the retail investments were focused more on the front end than on the back-end. As a result though most players have several stores in place, they have no rigorous supply chain to generate the cost efficiencies and fill rates needed to improve the bottom line and improve customer experience. Retailers are increasingly realising that it can be handed over to specialists. This is leading to rise in Third Party Logistics (3PL) industry, thus enabling retailers companies to leverage their resources, bring down fixed and working capital investment, spread risks and concentrate on core business matters vital to survival and future growth. Besides modern retail growth, other factors which have fuelled up 3PL growth are simplification of tax structure, increasing investment in infrastructure, increased incentives by Government through logistics parks, free trade warehousing zones coupled with correction in real estate prices which will lead to availability of retail space at cheaper cost and large investment in setting up big warehouses. Amid a surge in demand for logistics and warehousing activities, many logistics companies are reinventing themselves and targeting larger roles. The entry of global firms such as UPS, TNT, NV and DHL International GmbH has made domestic players better and more competitive. Traditional Indian logistics players are now organizing themselves in order to become more scalable. Even logistics players that provided limited supply chain services, are now moving to a strategic role that involves complete end-to-end solutions to improve efficiencies. As a result, while overall logistics pie is growing at a CAGR of 8%, 3PL revenues are growing at 22% faster than any other logistics segment. On the warehouse front too, we expect to see more activity. Historically, warehouses have been located in close proximity with primary markets. However, the abolishment of Central Sales Tax (CST) and an improvement in infrastructure would enable companies to realign their supply chain and move closer to consumer markets. As a result, demand for real estate will no longer be restricted just to the existing primary logistics hubs in the country and will boost the real estate market. However, it is unlikely that we will see the benefit of all the current and planned investments in the short term because most of the investments are either at nascent stage or would take time to reap benefits. Hence, the entire supply chain would still need more time, effort and investment to streamline, optimize and result in significant cost advantage and efficiency.

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Marketing Spends to Get Realigned- Increasing Share for PoS

Brand advisors/ sales staff Free sampling in some categories Promotions in terms of freebies, discounts etc Visibility Display aesthetics

07

Despite all the mass advertising, the truth remain that more than 60% of the purchase decisions are made at the point of sale. Key influencers and activations used are:

The economic downturn has increased focus on cost cutting measures and one area which companies are taking a relook at is their marketing investments. They are evaluating and attempting to optimize their Returns on Marketing Investments (ROMI). Many companies have stated their intent on cutting back marketing expenditure that is not yielding desired results and backing investments they are sure about. High viewership fragmentation on mass media like TV has made them look at micro marketing in a big way. A leading consumer products Company, which has followed the practice of running six-seven communication pieces for select brands within a year, is now planning to do just one or two. In tough times, marketers feel the need to create the urgency to buy a need fulfilled by tactical advertising. Therefore, the emphasis on new marketing models that look beyond the traditional media and television commercials like digital, mobile and PoS initiatives. It is expected that there will be a shift in investments from Above-The-Line (ATL or mass media) to Below-the-line (BTL) during the slowdown, partly because in absolute terms, the investments in BTL are lower and the flexibility to adjust the scale is higher. In 2008, the advertising industry grew at 14% to 15% while BTL expenditure grew by 18% to 20%. In 2009, it is expected that advertising spend would grow at 8% to 10% and BTL at around 15%. Experts believe that the shift in investments from ATL to BTL could be anything between 5% to 10%, depending on the advertiser. BTL also appears to be more productive. In mass-media advertising, only 2% to 20% may be the target customers Hence, even though it has a higher reach, it leads to more wastage and is less productive. On the other hand, promotions touch the consumer directly. As a result many companies are looking at radio, experiential marketing, PoS activation and digital media more seriously than they ever did. BTL may not always be tactical and short-term e.g. relationship marketing, hence it can lead to long term impact too. Therefore, We can expect that 2009 will be the year of non-classical advertising. The focus would be on becoming more productive, more effective and closer to point of sales.

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Retail HR - Reducing Costs and Balance Struck in Expat Recruitment

08

Reducing Costs 2008 has been a challenging year for retail. With the economic slowdown and falling sales, many retailers were forced to review and rationalize their costs. As a result overall employee remuneration witnessed a lesser growth and in some cases de-growth too in the last two quarters. Since the sales are not expected to change, it is expected that retailers will adopt a more cautious approach in 2009, given the need to further reduce/ rationalize costs. The irrationally high compensation packages which had become common for hiring talent in the past will now be fewer and far between. Companies will tend to focus on grooming internal talent and build from within to manage their future talent needs. This can be perhaps viewed as a good time for organizations to consolidate their HR strategies towards a high performance orientation and also look at eliminating HR redundancies. Balance Struck in Expatriate Recruitment Another retail HR related trend is the movement of expatriates. Several businesses in the last a few years had hired expatriates in their top management. This was primarily because the retail industry in India was at the nascent stage and there was a lack of local expertise and competencies in India. On the other hand, developed economies had people who had expertise in managing large retail businesses and were well versed with the best practices of the industry. Hence, many retailers recruited expatriates in their top management to mentor the Indian teams and establish their businesses. However, we have seen that many of these expatriates have moved back to their countries or moved on to other assignments. For instance one of the leading Indian retailer had hired 50 executives from leading retail companies across the globe. These executives came from mature markets such as the US, UK, France, Germany, Australia and Singapore and had at least 25 to 30 years experience in the retail business. From this pool of 50, around 30 executives returned to their respective countries in mid 2008. There are several reasons for movement of expatriates. Some of these are: High costs Cultural differences, making it difficult for expatriates and their families to plan long term stay Inability to handle the complex Indian retail challenges like the inefficient supply chain and lack of systems and processes Increasing availability of Indians returning to work in the country As organized retail is no longer an unknown territory it used to be, getting competent local talent is becoming relatively easier This does not imply that international expertise is no longer needed by Indian businesses now. However, Indian retailers are now more aware of the business environment and hence, would be able to identify specific areas where the expatriates can add real value to the business.

Authors Anil Rajpal, Vice President I [email protected] Pragya Singh, Senior Consultant I [email protected]
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