FDI in Indian Retail II

In my previous post on FDI in Retail, I kept the focus limited to numbers & stats, mostly formulated by consultancy firms. The people behind those projections happen to be some of the best brains in our country (handpicked by their employers at IIMs or Ivy League universities). So their analysis in my opinion carries more reliability than most government officials, who are either uneducated (I did not use the word illiterate because the definition of a ‘literate’ in this country is laughable) or too ignorant, or have vested interests (the most probable case). If questioned about their stance on FDI, or asked to explain that stance, they get agitated but fail to provide even one plausible implication of their stance. Sad but true!

So far, the critics of FDI have given reasons along the lines of the following:

• Kirana shops will close. International sourcing will destroy Indian MSMEs too. This will cause unemployment.
• Farmers will get exploited.
• International firms (with deep pockets) will form monopolies and manipulate prices. Hence, the consumers will also be exploited.
• The Gandhi family wants to bring in FDI to benefit their “foreign cronies”
• The manner of the policy announcement was “inappropriate” since the Congress did not do adequate “consultations” with the allies and opposition parties. 

However, if anything, these claims have been nothing but populist in nature and their ruckus so far has gained them hefty support from the poorly educated vote-bank, which is not expected to know any better. Some political parties and their supporters seem to be too preoccupied with the Luddite Fallacy, which simply put, is a belief that labor-saving technologies will cause unemployment. As you can tell, the problem with this is that nobody (neither individual nor nation) can progress, let alone innovate, holding such a premise as core value. So it comes as little surprise that when the Prime Minister made an executive decision, the opposition created a pandemonium, both in parliament and on the streets, and forced the government to suspend the proposal in the name of democracy.

Now then, I doubt I need to remind you of how Protectionism hurts the economy of the country that imposes it. Not only does it disincentivize competitiveness and specialization, thereby deterring potential exports, but it also supports incompetent businesses. One does not need to look too far to validate this as our own history offers enough pointers. Businesses that were protected from foreign competition eventually got complacent and did not bother to innovate to stay competitive. Such complacency sets in to all businesses that are protected as they do not feel threatened by competition and hence they become exploitative in nature themselves. I’m sure you can think of a few such businesses yourself. Personally, I am an advocate of the notion that competition brings out the best of any business, and those that get wiped out were obviously not competent enough. Organized retail – though currently only 6% of the total retail market – is here to stay and is expected to rise to 21% over the coming years. This means that the Kirana shops will not be facing competition for the 1^st time.

In fact, judging by the VAT collections of the kirana stores between 2000 and 2010, which increased from Rs 3300 Cr to Rs 8300 Cr, one can only say that they have done well to hold their place despite the emergence of organized retailers (See graph). If anything, this would be another opportunity for them to cement their place in their neighborhoods. How? Consider this example of this shopkeeper in Delhi :

In 2009:

• 500 sq feet store with typical kirana layout and design, open 16 hours daily
• Had 4 employees (2 sons and 2 hired), and total of 448 employee hours every week (4 employees x 16 hours x 7 days)

In 2010, it was time to innovate (& renovate) :

• Repainted walls, added 3 shelf racks, 2 fridges, and 1 air-conditioner
• From Kirana format, it migrated to the self-service format
• Renovation Cost = Rs 90,000 & Time = 45 days

In 2011, post renovation results:

• 80% growth in sales
• Employee hours reduced by 25% to 336 hours per week (2 employees could now work part-time 8 hour shifts)

This is a true story of a kirana shop embracing change, modernizing, and as a result, enjoying higher sales and lower costs, which translated to better profit margins. An average kirana shopkeeper (working in meager conditions) does not take home more than Rs 10,000 – 12,000 per month. So when his sales nearly doubled (for the sake of simplicity, let’s assume that the decline in wage-bill was equal to the rise in his electricity bill), his improved profits (and work environment) could go a long way in improving his livelihood. He could potentially scale up his purchases and hence improve his bargaining power; perhaps he could eliminate an intermediary, thereby further lowering his costs. What he actually does with that extra income could be anybody’s guess, but the key takeaway here is that competition brought the best out of him. Had there been no pressure from bigger and fancier stores opening around Delhi, he might never have bothered doing what he did.

Next, I want to draw your attention to the graph. It is a comparison of the rise in CPI (Consumer Price Index) in 6 cities between 2000 and 2010. As you can see, cities with more organized retail – Mumbai, Hyderabad and Delhi – had faced less inflation (measured by change in CPI) compared to other cities – Amritsar, Kanpur and Nagpur – where retail is relatively less organized. This is essentially because organized retailers have bargaining power that individual small shops don’t. And while the scale of our domestic organized retailers is not very large, it still managed to keep inflation significantly low. Now, if, or when, the government’s better sense prevails and FDI is finally permitted, the inflation will be even lower.

In my last post, I already highlighted how organized retail (with FDI) would bring superior scalability, eliminate unnecessary intermediaries, and establish a high quality back-end infrastructure of international benchmarks. One thing I would like to add to that list is that it would lower Shrinkage Cost, which is the cost of slippages such as employee thefts, vendor faults, administrative errors, shoplifting, etc. This, in case of India is as high as 4% of total sales (read: losses) compared to a benchmark of only 1.5% globally. Furthermore, According to Technopak, while Indian retailers currently hold their inventory for an average of 128 days, their foreign counterparts hold their inventory only for 38 days because of their ability to source directly from the producers. That statistic alone shows that their efficiency in inventory management is 300% higher. Statistics aside, foreign retailers will also instill professionalism in their dealings (paying the suppliers on time, no worker exploitation), and inculcate a strong work culture benchmarking best practices.

According to the DIPP, India produces about 180 million tons of fruits and vegetables, but has a cold storage capacity of only 23.6 million tons (5,386 standalone units). That is a deficit of about 87%, and according to CRICIL causes losses worth a whopping Rs 10,000 Cr annually. What’s worse is that more than 80% of that cold storage capacity is wasted on potatoes alone. Sadly, the fact of the matter is that currently, India is relying on infrastructure that is outdated by decades. It does not have a proper logistics network, but just a number of warehouses and transport offices scattered across the country. As the country (and its citizens) develops, it is going to need adequate infrastructure in place to facilitate its growth ambitions. The Planning Commission of India estimates that India needs an investment of Rs 60,000 Cr (about $13 billion) in its agricultural infrastructure alone. Only way that this is possible is if the government puts its politics aside and allows FDI in multi-brand retail.

Let me give a scenario where the Indian retail industry is protected and FDI is not permitted. The outcomes of this would be actually very undesirable. Lets take a look:

• No Foreign Capital Inflow – With no inflow of foreign capital, the Rupee will remain weak for the foreseeable future and our expensive imports will continue to exert inflationary pressures.
• No Technological Breakthrough – This, in my opinion, is more important that inflows of capital. I already spoke about these so I will not repeat myself, but I will remind you that the value that the likes of Wal-Mart and Tesco will bring in technological knowhow would be priceless. While we tout about our software exports, it is crucial to realize that we lag far behind the world in actually adopting some of those technologies.
• Slower Job Creation – Since there will be no FDI, the growth in organized retail will come from our incumbent companies. But with business confidence so low, corporate balance so leveraged and the cost of credit (interest rates) so high, the growth is going to be much slower. This means that fewer jobs will be created than otherwise.
• No Infrastructure Development – I think it’s about time we smell the coffee and admit that the Government lacks the ability (and perhaps political will too) to eliminate infrastructure bottlenecks that cost us over 2% of our GDP every year. For those who think I’m being over-cynical in this regard, just compare the quality of roads that have been built in the last decade (try to focus on the damage) with the quality of infrastructure built over 60 years ago and is now probably declared heritage property (compare the damage). The potholes, the railway accidents, the filthy streets, and the overall neglect speak for themselves.

By now, I’m sure you get the picture. However, before I conclude, I would like to make one suggestion on this policy. That is to increase the 30% local MSMEs sourcing requirement to 50%. This is because giant organized retailers source about 30-40 percent locally anyway in order to achieve cost-efficiency. Furthermore, it makes little business sense in trying to sell grainy Chinese rice to an Indian basmati-loving consumer base. Hence, by imposing a local sourcing target of only 30%, the government is not doing any favors for Indian MSMEs. Secondly, I hope the Indian government doubles the definition of MSMEs from an asset base of Rs 5cr ($1million) to Rs 10Cr as overtime, in order to be able to meet the large demands of the retailers, the MSMEs will need to increase capacity and will then no longer remain in that MSME category since their asset base might exceed Rs 5 Cr. Moreover, opening up the multi-brand retail markets to foreign firms will also require India to rethink about the legal infrastructure – something else that India needs desperately since our legal system is very outdated. Issues such as taxation, labor laws, procurement laws, and food and safety standards will all have to be revisited. A nation with an economy developing at such rate needs a legal system progressive enough to match it strides.

Finally, the Indian economy grew at an aggregate of 105% between 2005 and 2011. Today, rural income is rising, and consequentially rural spending (demand) is rising. The rural demands in the same period (2005-11) grew by 35% for milk, 70% for vegetables, and another 70% for packaged and processed food items. This further shows that not only are kirana shops going to stay, but also that removal of intermediaries will give the farmers and other rural communities more disposable income will then improve the standard of living, and hence the social fabric of those communities (a positive externality). This however has one more implication. As these rural incomes rise, and the villages and rural areas are developed, new towns will be formed. Furthermore, there is already intense migrating from villages to big cities already. This will then make the procurement and logistics of food across the country a very complex process. Hence, in order to avoid chaos, adequate investments and careful planning needs to be put in place before it gets too late. FDI will bring in both the resources needed (capital and expertise) to do just that, and should therefore be seen as a boon to our supply chain, and hence, to our infrastructure thus the entire economy.

Concluding this post, I would only say that FDI in retail is something that India needs (almost desperately) and hence should embraced with both arms instead of resisting. It could add about 4-5% to our GDP every year. Take a look at the chart above. It shows the breakdown of the costs a consumer pays for tomatoes. The farmer gets only 30% of the final price, the retailer takes 21%, and the remaining 49% is distributed among other intermediaries. Considering that organized retailers could source directly from the farmers, how much value do you now think the intermediaries add?

A study by ICRIER (Indian Council for Research on International Economic Relations) came up with some interesting insight.

• The average distance from a consumer is 1.1km for a kirana store, but 2.6km for an organized retailer. In fact, 64% of the smaller kirana stores well less than 500 meters away.
• 35% of the kirana stores recognize their regular customers and give them credit. In fact, credit sales are makeup 22% of their total sales. These kiranas also know their customers’ tastes and can follow the changing tastes.  

Take a look at the graph below. It shows what FDI Liberation in the Retail Sector did for China. Why China? Because of the similar population size, and traditional agricultural economic roots. But the similarities end there. Anyways, the India-China comparison can be left for another day. For now, I've only brought this up to raise a simple question. Can liberating FDI do the same for Indian Retail sector? 

Let me give you an example. You realize that you are out of bread or eggs one morning. How would you make that purchase? Would you go to the big retailer in your city, or just downstairs to the nearest kirana store? What if you realized you did not have change? Or were crunched on time? In case you didn’t realize where I am going with this, I’m only trying to remind you that your neighborhood kiranas have a place of their own in the Indian retail landscape and the likes of Wal-Mart, Tesco, Carrrefour SA, etc. cannot take their place. If anything, it is 7-eleven that we should be worried about!