Overambitious expansion, squeezed profit margins, and unsustainable operational costs have adversely affected India’s organized retail sector

Till recently, the government and the industry alike were betting big on the country’s organized retail sector, touting it as the growth engine for job creation and economy.

However, the faltering of Subhiksha, which had 1,600 stores till December 2008, seems to have shattered the hopes. Before Subhiksha’s debacle came into public glare, it was the shining example of a successful retail venture. Its founder R Subramanian was the blue-eyed boy of the industry. So what went wrong? Does it mean that the business model that supports discounted small-stores format is flawed or is Subhiksha only an exception?

The retail scene
The Indian retail sector is largely dominated by nearly 12 million unorganized players, who constitute nearly 90 to 95% of the sector, which is the highest in any country. On the other hand, the organized retail sector accounted for only 5 to 7% in 2008. Of these, nearly 80% of such outlets are small family-owned businesses. In 2008, the size of the retail industry was pegged at US$ 353 billion in an ASSOCHAM-KPMG joint study. It estimated that the sector would grow to $410 billion by 2010. The organized retail would value approximately $51 billion by 2010.

The retail sector can broadly classified into four major categories—food and groceries, consumer durables, apparel, and pharmaceuticals. These together account for almost 60 to 70% of the total retail market. Of these four categories, food and groceries account for the largest share of 74%, according to India Brand Equity Foundation (IBEF). The food and groceries segment is estimated at $152 billion. However, organized retail in this sector is just about 1% of the total share, which also indicates the lowest penetration level amongst other major categories. This had prompted many big and small players to grab a pie in the organized retail sector. The major players are Subhiksha, Spencer’s, Reliance Fresh, More etc.

The big question
Let us consider two points at this stage. One, a typical Indian household of two spends nearly 10% of its budget on purchasing grocery, vegetables and fruits. Two, products such as rice, wheat and pulses are utility items that are non-elastic. Several consumers whom DARE spoke to said the slowdown had not affected their spending on grocery, fruits and vegetables. A customer, Rekha Sharma said, “The recession has not made a big difference to my household budget on grocery, fruits and vegetables.” According to Piyush Sinha, Professor of Marketing and Chairperson, Centre for Retail at Indian Institute of Management, Ahmedabad, “Even during a recession, basic utility items like grocery and medicines will be bought and most retailers look at this segment. The Subhiksha story is not an exception but just a reflection of things to come.” If such is the case, then what is ailing India’s organized retail and is causing the closure of such outlets?

A flawed model?
When the era of organized retail started in India, a lot of players entered this segment. In the food and groceries section itself, players like Subhiksha, Reliance Retail, Big Apple, Sabka Bazaar, Spencer’s, More etc started opening outlets and most of them adopted the discounted small-store format. An industry insider says the model that these companies adopted was flawed because their expenses far outstripped profit margins. Thus, more money was seeping out in the form of discounts and operational costs, while less was coming back into the kitty. Their expenses, which included rentals, employee salaries, inventory, cost of monitoring etc, were higher than their margins. These stores were making money but were not profitable, he says.

The situation worsened with the expansion spree. Another reason is that they thought customers would be attracted by discounts, for which they eliminated the middlemen and started dealing directly with big fast-moving consumer good (FMCG) players. The FMCG players have their own vested interest and in the long run they would like to be in a commanding position than in a negotiating position, which would have been the case with organized retail players. Sinha substantiates the point and says, “If you give more discounts, your margins will further shrink and therefore you need more customers. A bigger store may not necessarily mean more footfalls. And if you do not have more consumers, your inventories will suffer because you will have the burden of more stocks to clear.”

Comments (4)

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written by Vasudev, November 03, 2009

Hi,

For Branded Items the retail-chain stores may be giving discounts but not in the case of in-house brands / unpopular brands.

For example, I was purchasing in Spencers/Reliance Fresh/Heritage stores, but for items like sugar, oils, some not-so-popular company items are priced more than my round-the-corner super store.

It is really foolish to go for these super stores thinking that we get discounts.

Once I saw a reliance fresh guy throwing out two/three sack full of vegetables as all of them got perished out and was a stock being received. This clearly tells the freshness of the vegetables/fruits being sold. and their understanding of the products/preservation requirements.

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Wise customer
written by yadav chandna, November 01, 2009

Yet another tribute to the wisdom of the India's Aam Aadmi.

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Big retail can never flourish without efficient infrastructure and logistics
written by M A J Jeyaseelan, October 31, 2009

Efficient distribution which includes retailing is an essential requirement fur upping the productivity bar. Nothing can eventually survive unless the concerned new activity results in a corresponding rise in the productivity of the economy

What the world is yet to understand the fine difference between a market opportunity and an economic opportunity. It is the lack of understanding of this basic concept that had plunged the world in to the abyss requiring so much of taxpayers money to pull the economies out of trouble.

What most consultants, business associations, bankers, and venture capitalists have been focusing on in the retail sector is the market opportunity it offers. Consumers do want better retail services. That certainly presents a huge market opportunity.

But the ultimate question that begs an answer is whether the big retail is able to provide these better services at a lower cost. Can the market opportunity be translated in to an economically viable opportunity. I do not see that happening yet.

There are two parameters that do not at all permit any favourable forecast for retailers. 1) The land cost and the resultant commercial space cost. Both remain artificially high, thanks to the massive imperfections in the real estate market. The real estate market is being so unscrupulously manipulated by all and sundry making marginally more efficient services to cash in on any market opportunity. 2) Logistic quality and costs make cost efficient retail services almost impossible. There is no assured power supply. There is no cold chain infrastructure. Transportation remains a huge bottleneck.

Most retailers are attempting adopt models that have worked in good quality logistics and low commercial space cost environments. Unless the government removes the imperfections in the real estate market and undertakes a crash program to improve logistics, the retail dream is only going to bleed.

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Hmmm..
written by Mahadevan Sundarraj, October 31, 2009

Very well written, but should have been timed earlier. I spoke about this in 2007, and found very few takers. A link to that presentation written in Dec 2007 titled "Myths in Food retailing" is available at http://www.collabrant.in/content/Overseas Management Partners in India.htm

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