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  1. 1. FDI in Multi-brand Retail: The Next Big Thing in Reforms, but Roadblocks Persist: India Knowledge@Wharton(http://knowledge.wharton.upenn.edu/india/article.cfm?articleid=4581)FDI in Multi-brand Retail: The Next Big Thing in Reforms, but RoadblocksPersistPublished : March 24, 2011 in India Knowledge@WhartonThe Economic Survey of India is a document presented to Parliament by thegovernment a few days before the Union Budget. It is an analysis of thestate of the economy and its prospects. Economists and analysts scan itclosely because it very often reflects policy changes that will be announcedin the Budget.Economic Survey 2010-11, tabled in Parliament on February 25, had this to This is a single/personal use copy of Indiasay about the retail sector: "Permitting FDI (foreign direct investment) in Knowledge@Wharton. For multiple copies, custom reprints, e-prints, posters or plaques,retail in a phased manner beginning with metros and incentivizing the please contact PARS International: reprints@parsintl.com P. (212) 221-9595existing retail shops to modernize could help address the concerns of x407.farmers and consumers. FDI in retail may also help bring in technicalknow-how to set up efficient supply chains which could act as models of development."The Survey is essentially talking about multi-brand retail -- the Walmarts and the Carrefours. Indiapermits 100% FDI in cash & carry and wholesale trading (which is business-to-business) and 51% insingle-brand stores (such as Gucci or Apple). Says the Survey: "FDI in retail trading is permitted inBrazil, Argentina, Singapore, Indonesia, China and Thailand without limits on equity participation, whileMalaysia has equity caps."India was expected to join this long list of countries. But this year, finance minister Pranab MukherjeesBudget didnt include any mention of retail, except for some concessions and incentives for the coldstorage sector. "We expect [permission for FDI] to come in phases," says Pinaki Ranjan Mishra, Ernst &Young (E&Y) partner and national leader, retail and consumer products practice. "This sector needsfunding, and FDI is a good source of funding." Adds Thomas Varghese, CEO of Aditya Birla Retail andc hairman of the Confederation of Indian Industry (CII) National Committee on Retail: "While there wereexpectations from the industry regarding the announcement of FDI in retail, we do realize that the Budgetis not an exercise to announce policy measures."Green Signal This Summer?Since the Budget, there has been a steady stream of indications that the green signal for FDI is on its way."Expect something before the summer is out," the newspaper Hindustan Times reported commercesecretary Rahul Khullar telling the U.S.-India Business Council in mid-March. In New Delhi, U.S.economic, energy and business affairs additional secretary Jose W Fernandez told the Indo-AmericanChamber of Commerce that easing of the retail ban would give a big boost to FDI flows into India, whichhave been declining the past couple of years.While retail has been left in cold storage, other reform measures are making some progress. A day afterthe Washington statement, the Union Cabinet approved the Pension Regulatory Fund & DevelopmentAuthority Bill. Among other things, this allows 26% foreign investment in the sector. Before that, thegovernment had approved a move to amend banking regulations to allow more foreign investment in thesector. Mukherjee has also appealed to industry to help build a consensus to allow foreign investment inthe insurance sector to be increased from 26% to 49%. These bills will, of course, have to be cleared byParliament before they become law.Its Parliament that is the stumbling block. The government has already been hit by a string of scandals(see Capital Plight: What Drives Corruption in India?). Now theres even more. A close aide of arrestedtelecom minister A. Raja has committed suicide; an investigation is taking place. U.S. diplomatic cables   All materials copyright of the Wharton School of the University of Pennsylvania.                    Page 1 of 5 
  2. 2. FDI in Multi-brand Retail: The Next Big Thing in Reforms, but Roadblocks Persist: India Knowledge@Wharton(http://knowledge.wharton.upenn.edu/india/article.cfm?articleid=4581)telecom minister A. Raja has committed suicide; an investigation is taking place. U.S. diplomatic cablesposted on WikiLeaks say that opposition members were bribed to vote for the government or abstainduring a trust vote in July 2008. Says Harish Bhat, chief operating officer (watch division) of TitanIndustries: "This is a politically sensitive year."Elections are coming up over the next few months in four states. FDI in retail has been projected as ahuge threat to the unorganized sector -- the kiranas (mom-and-pop stores). "The Indian retail sectorcomprises 13% of GDP and employs 6% of the nations workforce," says a 2008 PricewaterhouseCoopers(PwC)-CII study titled, "The Benefits of Modern Trade to Transitional Economies." Allowing FDI at thisstage could alienate this huge vote-bank.Passing the BuckExpectedly, the subject is a hot potato. An inter-ministerial group set up to make recommendations on theissue has passed that responsibility on to the Cabinet. "[The group] has restricted itself to analyzing thepros and cons of such a reform," says business daily Financial Chronicle. "The group has vetted 175responses from stakeholders to a discussion paper on FDI in multi-brand retailing. Opponentsoutnumbered supporters by 109 to 63 while three were neutral.... 73 of the 109 opponents belong to onecategory -- local traders and retailer associations. Other opponents include manufacturers, small retailersand NGOs (non-governmental organizations). Supporters [included] industry chambers, including apexchambers CII and FICCI, national institutions, think tanks, organized retailers, law firms and prospectiveinvestors." Says the PwC-CII paper: "Allowing FDI into the retail sector will usher in large globalcompanies who will need to hire millions for their pan-India retail operations."The PwC-CII paper adds that there are around 12 million kirana stores in India. It is this constituency thathas been mobilized to oppose FDI in retail. The more vociferous elements, however, are the middlemenand traders. They stand to lose their livelihoods altogether, while most observers -- including think-tanksbrought in by the government to study the issues -- feel the kiranas will be successfully integrated withmodern retail.Others who could have been expected to be against FDI in retail are the established chains. But opinionhere is divided. "We are not against FDI in foreign retail," says Kishore Biyani, CEO of the FutureGroup, Indias largest retail chain. "The government understands what is required for the country and itwill do the needful." Govind Shrikhande, managing director of Shoppers Stop, has a question for theWalmarts and the Carrefours: Why arent they going the whole hog in the cash-and-carry segment where100% FDI is allowed? (Carrefour opened its first cash & carry store in India last December; Walmart hasfive such stores in India in a tie-up with telecom major the Bharti Group.)"At Reliance, we are okay with FDI not coming in," says Bijou Kurien, president and chief executive(lifestyle) of Reliance Retail, a Mukesh Ambani venture. "We have partnerships only in the specialty andluxury space with marquee brands [like Marks & Spencer, Office Depot, Hamleys] and not in thebig-ticket hypermarket or grocery space. We have run the distance long enough by ourselves. Afterhaving burnt our fingers during this learning phase we dont want to get into partnerships now and shareour topline and bottomline."Varghese is on the other side of the fence. "Both from an industry perspective and as head of Aditya BirlaRetail, we would be delighted if FDI in retail is announced," he says. "We look at it as one of the biggestsources of funding for our future growth plans. We look at it more from a funding aspect rather than thepoint of view of strategic domain expertise even though that is also important. As domestic retailers, wedont feel threatened. We think that high quality international competition will be good for us."Money MattersThe funding -- though overshadowed by the kirana issue -- is important. Some domestic retailers havehad to fold up because they expanded too fast and couldnt finance their plans. "The past two to three yearshas seen the collapse of some big retailers of the 2006-2008 boom," says Kurien of Reliance. He gives theexample of Vishal, Subhiksha and Koutons. While Subhiksha has closed down, Vishal was sold inmid-March for US$15.5 million. Three years ago, it was valued at US$500 million.People with deep pockets -- like Reliance, the Birlas or the Tatas (group retail flagship Trent has a tie-up   All materials copyright of the Wharton School of the University of Pennsylvania.                    Page 2 of 5 
  3. 3. FDI in Multi-brand Retail: The Next Big Thing in Reforms, but Roadblocks Persist: India Knowledge@Wharton(http://knowledge.wharton.upenn.edu/india/article.cfm?articleid=4581)with Tesco) can ride out the downturns. Newer players dont have that luxury. "Last time, funds wereavailable from bankers and private equity investors," adds Kurien. "But having burnt their fingers, theyare now very careful about lending to retailers. [The period between] 2006-2008 was also led by aproperty boom."The cost of real estate is one of the biggest challenges for retailers, says Anshuman Magazine, chairmanand managing director of real estate consultancy CB Richard Ellis. "Rentals have now been negotiated ona revenue-sharing basis," he says. "That helps as the upfront cost and, therefore, the risk is lower."Real estate -- particularly the prime real estate they are now occupying -- gives the small firms a smalledge over newcomers. "The small players have a locational advantage -- especially in large cities," saysPrashant Agarwal, joint managing director of strategy consulting firm Wazir Advisors. He feels that whenthe foreign players come in, the marketing wars will be fought mainly in newly-developing urban centers.Adds Bhat of Titan: "A lot of the expansion for both Titan and all major retailers is going to happen in theTier 2 and Tier 3 towns." Titan has 650 stores today and plans to add 300 more in 2011-2012.Everyone on Expansion PathLike Titan, others are planning expansion. Reliance Retail currently has around 1,150 stores. Accordingto Kurien plans are to increase the number to 1,500-1,600 in 2011-2012. "Except for a six-month period in2008-2009, we have been expanding continuously. But we resumed expansion with a qualification; weare now looking only at those formats which are performing well. Everyone realizes that expansion needsto be done in a measured and calculated manner." Incidentally, the US$1 billion turnover Reliance Retailis still in the red. "But there are pockets of profitability. We have not built scale as yet," says Kurien.Aditya Birla Retail has 554 supermarket stores and nine hypermarkets. "We plan to put up another 120supermarkets and 10 hypermarkets in 2011-2012," says Varghese. At its peak in 2008, the company hadaround 750 supermarkets. "But we closed many of them as part of a cleaning process," adds Varghese."We are currently profitable at the store level," he continues. "We will be profitable at an enterpriseEBIDTA (earnings before interest, depreciation, taxes and amortization) level by March 2013. And wewill be a cash positive company by 2015-2016. We are on course on these milestones."At the Future Group, Biyani is selling stakes in several companies to retire debt and focus on his coreretailing business. The diversifications in which he is partly divesting include consumer finance,insurance and logistics."The next two-three years will see most of the players expanding their scale aggressively across thecountry," says Mishra of E&Y. "In the retail business you have to expand to increase your profits. Thereis no other route." The bottomline is that everyone -- big and small -- needs money. "This sector needsfunding and FDI is a good source," Mishra says. He expects the easing of FDI rules to be phased out."Many Indian retailers who are cash strapped are looking forward to FDI in multi-brand retail for theinvestments that it will bring in," says Varghese of Reliance. "It will also make joint ventures easier,simpler and cleaner."The Charm of the Indian MarketIndian companies need money. But what explains the attraction from the other side? Why is FDI in retailbeing built up as the beacon of the next phase of liberalization? The answer is in the numbers. Accordingto the governments Economic Survey, "The retail sector is expected to record healthy sales in 2010-11and grow by 10.2% in 2011-12. The sectors PAT (profit after tax) margin is expected to expand over thenext three years on account of a faster rise in income vis-a-vis expense." Adds the PwC-CII study: "Indiais ranked as one of the worlds most exciting retail destinations." The study says that Indias retail sectoris worth an estimated US$350 billion and is growing between 30% and 40% per annum. (This relates to2008, but there is a huge divergence in the absolute numbers and growth estimates put forward by variousorganizations.)"Despite about 75% of Indias population earning less than US$2 a day, the Indian retailing context couldappeal to foreign firms due to rising income levels of consumers in several segments; the low penetrationlevels of several product categories; the huge presence of the unorganized sector with regard to offeringsthat provide scope for penetration of branded goods; the emerging youth population that is going through   All materials copyright of the Wharton School of the University of Pennsylvania.                    Page 3 of 5 
  4. 4. FDI in Multi-brand Retail: The Next Big Thing in Reforms, but Roadblocks Persist: India Knowledge@Wharton(http://knowledge.wharton.upenn.edu/india/article.cfm?articleid=4581)a radical change of lifestyles; and, of course, the unorganized nature of retail sector itself," says S.Ramesh Kumar, professor of marketing at the Indian Institute of Management Bangalore. "However,unlike in the West, the kirana stores will continue to be a part of the Indian scenario for several yearsgiven the shopping styles of consumers (only a fraction would be interested in driving to huge stores tostock up items for the entire week). The culture of shoppers to shop daily coupled with lack of storagespace make the kirana store a part of the Indian middle class."Kumar doesnt see smaller Indian retailers giving up in the face of a FDI invasion. "The small organizedneighborhood store [like Subhiksha] with limited SKUs (stock-keeping units) offering discounts toconsumers is also a good strategy provided they are able to get the supply chain and choice ofmerchandise right."He gives a snapshot of the future of retail in India as he sees it. "Multiple formats will become the trend[like the Tescos chain in the U.K.]. Private labels offering good value will have huge scope given theescalating prices of conventional branded offerings. Retailers like Reliance or Big Bazaar [Future Group]will have an advantage due to their scale. Such outlets will attract a huge consumer base in urban marketsdue to their variety as well as value-based sales promotion plus private labels. Consumers will divide theirpurchases between kirana stores and modern retail outlets."Organized Sector GrowingFor many, India is an inevitable destination. According to the 2010 A.T. Kearney Global RetailDevelopment Index report, the retail market in India is worth about US$410 billion. "But only 5% isthrough organized retail, meaning that the opportunity in India remains immense," says the report. "Retailshould continue to grow rapidly -- up to US$535 billion in 2013, with 10% coming from organized retail."A.T. Kearney puts India as one of the top three countries in retail expansion. It has, however, slipped acouple of notches from the No. 1 position it occupied until recently."The retailing industry is now estimated at US$420 billion and organized retail is estimated at US$20billion," says Agarwal of Wazir. "In 1990 the size of the industry was around US$120 billion andorganized retail around US$0.6 bn. So while growth in the retail sector has been around four times, theorganized retail sector has grown about 35 times." While organized retail has been growing in size, the kiranaskiranas have been growing in numbers. Agarwal estimates that the mom-and-pop stores have gone upfrom 7 million to 12 million in the same period.If FDI is going to happen anyway, why is there so much excitement about it now? The reason is that thisis an opportunity to push it through. India, like many other parts of the world, is suffering from high foodinflation; at its peak earlier this year, it crossed 18%. India, unlike other parts of the world, suffers fromhuge wastage in the food chain. "Researchers estimate avoidable supply chain costs (wastage, excessinventory and excess transportation costs) in Indian food and grocery sales to be about US$24 billion,"says the PwC-CII report. "One of the arguments in favor of FDI is that it will bring with it thetechnologies and expertise required to build robust food supply chains."The Reserve Bank of India (RBI) is concentrating on tackling inflation and is raising interest rates. This,in turn, is making the cost of money too expensive for companies and they are postponing investmentplans. The heady GDP growth that India is expecting can get derailed if inflation continues to stay high.FDI in retail can thus be sold as a solution for inflation -- the food inflation component -- withouthampering growth. It makes it more palatable to constituencies opposed to the idea.Not everybody accepts the connection, however. "I think modern retail has nothing to do with foodinflation," says Biyani of the Future Group. Shrikhande of Shoppers Stop says there can be a noticeableeffect only when organized retail touches a 20% share. "That does not look likely for the next 10 years,"he says. Adds Varghese of Aditya Birla Retail: "It is believed that FDI will help in controlling foodinflation by improving the supply side. Of course, even today there is no restriction on FDI in the coldchain and the supply chain. But then which [foreign] player would want to invest in this without havingthe comfort of knowing that the front end will also be open to them."If the straws in the wind are to be believed, FDI in retail could happen any day. In the latest installment ofthe WikiLeaks saga, its the opposition Bharatiya Janata Party which is in the dock; the leaked cablesshow that the party was apparently opposing the nuclear deal in July 2008 merely to win some brownie   All materials copyright of the Wharton School of the University of Pennsylvania.                    Page 4 of 5 
  5. 5. FDI in Multi-brand Retail: The Next Big Thing in Reforms, but Roadblocks Persist: India Knowledge@Wharton(http://knowledge.wharton.upenn.edu/india/article.cfm?articleid=4581)show that the party was apparently opposing the nuclear deal in July 2008 merely to win some browniepoints. It had assured U.S. diplomats that it wouldnt seek to amend the deal if it came to power. Yes,elections are coming. But these are to state assemblies and will not affect the composition of the LokSabha, the lower house of Parliament. This could be just the time to open the floodgates a bit. Says Bhatof Titan: "FDI in multi-brand retail is one of the most progressive steps the government can take."This is a single/personal use copy of India Knowledge@Wharton. For multiple copies, custom reprints, e-prints, posters or plaques, pleasecontact PARS International: reprints@parsintl.com P. (212) 221-9595 x407.   All materials copyright of the Wharton School of the University of Pennsylvania.                    Page 5 of 5