Organized Indian Retail: Challenges ahead for Organized Retail

Booming economy, favorable demographic patterns, increasing per capita income and urbanization gave rise to a new sector in India: Organized Retail. Opening up of retail sector for FDI can be considered as the prime reason behind the blooming organized retail sector. Sensing this opportunity several companies ventured into this sector, including Reliance, Bharti and Pantaloons.

Despite the Government allowing only 51% of FDI in single format retail segment, global retail giants like Tesco, Wal-Mart and Metro AG are making inroads indirectly through franchise agreements and cash and carry wholesale trading, thus giving some serious competition to domestic retailers. Nevertheless, growth opportunity in this sector can be judged by the fact that only 3% of the total retail sector is organized and 97% of the sector still consists of local mom and pop stores.

Unfortunately, the growth strategy used by all organized retail players of increasing their number of stores backfired when rentals dramatically shot up following the global economic melt down. Profitability is seriously hampered and almost all major retailers are now struggling to maintain their bottom line. Average operating profit margin declined from 9.5% in 2007 to 7.9% in 2008. The worst part is that such a drastic growth in the number of stores was backed by significant leverage which is expected to further hurt these organized retailers’ liquidity and profitability levels.

Retailers are correcting their over enthusiastic strategies of the past and focusing on improving their business model. This section will review some of the challenges these organized retailers are facing on both macro as well as local levels.

Aggressive Expansion

Over the last few years Indian retailers most preferred mode of expansion was to increase their number of outlets across metros. Outlets were built wherever real estate was available and not where they were actually required, which led to ‘Clustering’. Following credit crunch in 2008, several outlets were cast strapped and had to be closed down simply because they were operating in unviable locations.

Poor Supply Chain Management

One of the major challenges for retailers is to reduce shrinkage which includes short-weighing, pilferage and poor product handling. While the average shrinking percentage of inventory in developed countries is 1% to 2% of Cost of Goods Sold, it is estimated to be much higher for Indian retailers, primarily due to the lack of focus on supply chain management. The existing supply chain is not devoid of inherent weakness of India’s infrastructure, besides being corrupted along the entire chain. Tracing shrinkage is a Hercules task as almost all the transactions still continue to be based on paper system. This gives rise to the need of third party logistics organizations that can provide services at competitive prices. Third party logistics is a concept still absent from the Indian retailers’ value chain.

A large part of shrinkage takes place within the retailer by its employees. Moreover, tracking an employee’s track record and background checks is difficult. Retailers are now joining hands to fight this battle by creating a database of employees and share it amongst themselves to avoid shrinkage from within.

Employee training and retention

The most common strategy applied by retailers to keep labor cost at minimum was to employ fresh graduates with no experience in retail sector. They have now realized that in difficult market situations, experienced and talented employees that have sound understanding of ground realities could give retailers a competitive advantage. Despite a downturn, need for skilled manpower still continues to be a major concern across the sector.

Managing working capital

One of the most important factors affecting a retailer’s profitability is the way it handles its working capital. Lower footfalls, resulting into lower sales has directly impacted Indian retailers’ working capital position. Discounting is now the most common technique used to turn slow moving inventory.

Besides lower footfalls another factor which is hurting retailers’ liquidity position is the significant amount of leverage they are carrying which was used earlier for aggressive expansion. Banks are now reluctant to finance retailers given the falling demand and plummeting profitability. Retailers are therefore finding it difficult to finance their working capital requirements.

Diversifying into untapped rural areas

Experts believe that the next phase of growth for organized retail sector will come from rural areas that account for half of the $300 billion domestic retail market. Retailers will have to focus on the previously untapped lower income strata by providing them access to credit facilities. On the back of souring commodity prices and improving productivity, rural economy is set to boom in the next decade.

Backward Integration

One way to improve efficiency and profitability is to remove unwanted intermediaries which eat into the already stressed margins. To improve rural economy, Indian Government approved Contract farming and Leasing. According to KPMG, this will bring about technology transfer, increase capital inflow and assure market for crop production, besides eliminating intermediaries. Pepsico and ITC’s e-chaupal are already benefitting from contract farming in Northern India.

Despite the above mentioned challenges, long term prospects of organized retailers are still very attractive. Important consolidations and partnerships can be expected soon for improving operating and cost efficiency. Focusing on supply chain management and partnering seem to be the need for an hour for organized retailers so as to leverage their expertise and financial muscle.