FASHIONING A WINNING TRAIL - How to build sustainable business models in Indian apparel retail

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FASHIONING A WINNING TRAIL
How to build sustainable business models in Indian apparel retail

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Kanvic is a management consulting firm helping businesses develop
winning strategies, drive profitable growth and achieve operational
excellence to reap long lasting rewards in the fast growing Indian economy.
We work with C-level executives to develop innovative solutions for the
business challenges of 21st century India by bringing in leading edge
management thinking informed by in-depth research and sound analysis.

FASHIONING A WINNING TRAIL
Deepak Sharma
Ravindra Beleyur
Gehan Wanduragala
Shiv Kumar Sharma
kanvic.com
November 2013

About the Authors
Deepak Sharma is a partner and co-founder at Kanvic where he leads the strategy
practice. Ravindra Beleyur is a partner and co-founder at Kanvic where he leads the
corporate finance practice. Gehan Wanduragala is an associate consultant in India and
the UK and works closely with international companies tapping the Indian market.
Shiv Kumar Sharma is an associate consultant in the strategy practice.
Acknowledgements
Kanvic would like to acknowledge the contribution of the team behind the report. We
would especially like to thank Sagnik Dasgupta for his extensive research in the sector
to build and test initial hypotheses. Clement Rougeron contributed in conducting
substantial analysis for the report. Vlad Flamind gave editorial inputs.
Further information
We welcome your questions and comments on this report. For further information,
please contact us at:
Email: deepak@kanvic.com
Phone: +91 99283 77800

Contents
Foreword 9
Executive Summary 11
Evolution of Indian apparel retail 17
The elusive success of apparel retail in India 23
The root cause of failure
High risk growth
A crisis of leadership
The weakness of surviving business models
Emerging as a winner in apparel retail 41
Improve business economics
Get the growth strategy right
Stress test the business model
Make the right entry decisions
Demonstrate boldness in exiting
Look at the right metrics
Conclusion 59

Foreword
On the surface, apparel retail seems to be the standout success story in India’s
journey towards modern retail. Organised players represent a larger share of the total
organised retail market than any other retail category. What is more, they have
achieved this status with little of the political controversy that has blighted the
modernisation of other categories. However, despite this rapid rise and the seemingly
huge market potential, business success has been elusive for India’s apparel retailers.
At Kanvic we were both intrigued by this apparent paradox and unsatisfied by the
consensus explanations that largely blame the high cost of rentals in India. As a
result, we set about identifying the real issues, with a view to charting a sustainable
and profitable way forward for Indian retailers.
As a first step we built a comprehensive database of Indian apparel retailers and
tracked the growth of the retail space they occupied over the last decade. We then
segmented the retailers into distinct groups according to their strategies and their
reasons for failure. From each of these groups we studied a representative sample of
players in detail by reviewing their annual reports, the interviews of their leaders, and
their financial performance. We then benchmarked these retailers against the top
global players to understand the differences in their profit model. As we continued our
analysis we validated our findings with industry players and against our own
experience of the on-the-ground realities in the sector.
Finally (and most importantly), on the basis of our extensive analysis and experience,
we identified and developed six key steps players can take to build sustainable
business models and fashion a winning trail in Indian apparel retail.
We hope the resulting report will be of real interest and practical value to your
organisation. We welcome your comments and we look forward to beginning a
conversation about how the report’s findings and recommendations relate to your
business context.
Deepak Sharma
Director and co-founder

Executive Summary
The elusive nature of success in India’s apparel retail industry has left many of its
incumbents struggling, while still many more have fallen by the wayside during the
economic turbulence of recent years. This report looks at the root causes of failure in
the sector and highlights the persistent weakness of the surviving players. It then
moves on to address the six key areas where Indian apparel retailers need to take
action if they are to build the sustainable business models that will win in the future.
The emergence of organised apparel retail in India has been rapid, outstripping that of
other categories and attracting significant investment from private equity. It has also
seen rapid evolution as retailers sought to attract customers away from the
unorganised sector through greater convenience, improved experience, and lower
prices. However, by tracking the performance of leading retailers from 2008 to 2013,
we have observed how the sector has been marred by a high number of failures.
Kanvic analysis shows that players representing over 30% of the total apparel retail
space in 2008 have either closed down or sold their business. Retailers representing a
further 22% of the space are currently struggling i.e. reducing the size of their
business or actively looking to sell. Whereas retailers accounting for less than half of
the retail space in 2008 have been able to improve their business performance over
the last 5 years.
Struck by this high failure rate in a rapidly expanding sector, Kanvic looked to identify
the root causes. Our analysis found that the high risk growth strategies of retailers
and a crisis of leadership within their organisations were the critical factors in bringing
about failure. Firstly, the drive for rapid top-line growth and a massive expansion in
store numbers led many retailers to take on unsustainable levels of debt, leaving
them dangerously overextended when the slowdown hit.
These high risk growth strategies were closely related to the second cause of failure:
a crisis of leadership. First and foremost, many retail leaders fell into the trap of
making linear growth assumptions based on the heady economic sentiment of the mid
2000’s. Seeing uninterrupted growth ahead, they perceived ‘execution risk’ as the
most serious threat to their success. This meant opening more stores than their
competitors in a race to lock down the best locations in a real estate market where
quality, availability, and rentals posed significant challenges. These overly optimistic
growth assumptions were exacerbated by a prevailing state of hubris among many
retail leaders, as they took early success to be an indication of the unique strength of
their business models and their own capabilities. With such overconfidence in their

own abilities, retail leaders failed to expand the management bandwidth in their
organisations. They concentrated control in a small group of promoters and relied on
micromanagement, leaving them unable to manage the increased risks that came
with growing business complexity.
Explaining why many Indian apparel retailers failed is only half the story though.
Perhaps even more important for the industry is to understand why those who
survived have yet to develop the kind of robust business models that are necessary to
win in the sector. By benchmarking the top Indian retailers against the global leaders,
Kanvic found that their average profit margin (as measured by EBITDA) is less than
half that of their international peers.
The consensus explanation for this low profitability has been the high cost of rentals in
India. However, Kanvic analysis has categorically found that high rentals are not the
main cause of poor performance by apparel retailers. As a percentage of total sales,
average rentals for Indian retailers are slightly lower than those of their international
peers. In fact, operating costs overall are lower for Indian retailers thanks to
substantially lower employee costs. The real culprit for poor profitability is the low
gross margins of Indian retailers.
Kanvic analysis shows that these low gross margins are the result of two prevailing
factors among Indian apparel retailers: poor supply side economics and low price
realisation.
On the supply side, Indian retailers are being squeezed by an inefficient and
fragmented garment industry and their weak bargaining power relative to apparel
brands. With Indian garment manufacturing characterised by small scale producers
using relatively low levels of technology, inefficiencies are passed on to retailers in a
higher cost of goods. Furthermore, as brands and manufacturers pursue forward
integration by opening their own Exclusive Brand Outlets (EBO’s), they reduce their
dependence on retailers, allowing them to demand high margins.
On the demand side, retailers’ margins are being squeezed by their weak bargaining
power with customers and the high level of mark-downs. Most of the basic innovations
of organised retail such as air conditioned stores and a wide selection of brands have
now become generic. With a lack of clear differentiation between many apparel
retailers both in product and experience, the highly value conscious Indian consumer
is unwilling to pay a premium and aggressively seeks out discounts. This tendency
combined with a lack of effective mark-down management is destroying value across
the sector.
With a scenario of low gross margins and a highly uncertain domestic and global
economic climate, the clear imperative for Indian apparel retailers is to take decisive
Fashioning a winning trail
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action to strengthen their business models. Through extensive research and on-the-
ground experience in the sector, Kanvic has identified six key steps they should follow
to get on the winning trail:
1. Improve the Business Economics
First and foremost, retailers need to improve their business economics by reducing
the cost of goods sold and increasing sales. The former requires the right sourcing
decisions, including carefully considering the potential advantages of imported
garments from lower cost manufacturing countries. Whether sourcing abroad or at
home, retailers will need to make substantial investments in their supply chain to
reduce lead times, improve quality and continually reduce costs over the long-term.
Additionally, retailers will need to increase the share of private label products in their
stores.
In order to increase sales, retailers must first clearly differentiate themselves. This
requires identifying their target segment, getting a deep understanding of customer
needs and consistently delivering a unique customer experience. At present retailers’
catch-all approach is failing to satisfy an increasingly fragmented Indian consumer
market. In delivering a differentiated experience, improved customer interaction with
the store staff is critical - and this is a major area of weakness for Indian retailers.
Secondly, retailers need to shift away from today’s largely push based supply model
that involves placing an ‘all in’ bet on the next season, and towards a push and pull
model that gives them the flexibility to supply according to actual customer demand.
This can be achieved through shorter planning cycles and by breaking down the
product range according to the predictability of demand.
Thirdly, retailers must implement effective mark-down management. By setting the
level of possible mark-downs for each product line ahead of the season and
integrating it in their financial planning, retailers will have a clear picture of the
implications of price reductions on profitability. Furthermore, by closely tracking
throughput of a line, minor price reductions can be made in-season to avoid the need
for deep end-of-season sales.
Lastly, retailers can reduce the price elasticity of their customers by employing loyalty
tools to segment and target consumers, as well as complementing it with the all
important personal touch of in-store staff.
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2. Get the growth strategy right
While Indian retailers have focussed on store expansion as the main driver of
revenues, sustainable growth demands finding the optimal balance between new store
openings and increased sales productivity. Kanvic has developed a proprietary model
for retail growth strategy that captures these critical aspects. The model’s key inputs
in determining the future growth strategy for a retailer are their current profit levels
and the degree of financial leverage in the business. Different growth strategies can
be played out under a range of future scenarios to see how they fare in varying
market conditions. This modelling exercise can practically help retailers re-calibrate
their growth strategy to ensure its sustainability.
3. Stress test the business model
In order to build resilience to future crises, retailers need to stress test their business
models under different economic scenarios. This can reduce the risk of being
blindsided by future shocks in demand or supply. The first step is to prepare a
baseline business plan with the current assumptions, and then assess its performance
under optimistic and pessimistic scenarios. These must be extreme but still probable.
Testing the business model against these extreme but probable scenarios - rather
than incrementally tweaking the key variables - puts it under real stress, and reveals
the performance outcomes in such situations. However, it is important that this
activity is conducted by someone emotionally detached from the strategy and can
take an ‘outside-in’ approach to reveal potential blind spots. On the basis of this stress
testing retailers can take action to mitigate the potential risks by, for example,
reducing their leverage, increasing cash reserves or altering the future plans.
4. Make the right entry decisions
Choosing when and where to open new stores is critical to retail success. However,
many Indian players have fallen into the trap of entering unviable locations to meet
ambitious expansion targets or, as a speculative hedge against future trends in the
real estate market - such as a rise in rentals or a shortage of supply. The result is that
ill-thought out market entries have undermined the overall sustainability of their
business.
Instead, before opening a new store retailers need to assess the overall demand and
supply situation in the given geography to fully understand its potential. In India this
can vary dramatically between for example, a developed market like Pune in
Maharashtra and an undeveloped market like Bikaner in Rajasthan. Once they have
decided on the target cities, retailers must drill down and assess the attractiveness of
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the market according to the presence of their target customer segment and the level
of competition from retailers in the same strategic group. This detailed analysis can
reveal profitable micro markets which can help determine the exact store location.
Furthermore, the fit of a new store location with the existing or planned network is
very important. Increasing store density in one area rather than leaping to new
regions can produce greater economies in distribution, market knowledge, personnel
and advertising spend.
5. Demonstrate boldness in exiting
Being able to objectively assess the viability of a store location or product category
and make a prompt exit is a necessary discipline for retailers. Although store closures
are a common phenomenon among top global retailers, we have seen great
reluctance by leaders in India to exit loss-making positions. This reluctance comes
from our human nature to be loss averse. In fact research has shown that we value a
loss at as much as two-and-a-half times that of a gain of the same magnitude. To help
maintain an objective focus, retailers need to closely track actual performance versus
projected sales and regularly review the time to break-even. A quick exit can stem
losses early and allow resources to be focussed on more profitable parts of the
business.
6. Look at the right metrics
As the saying goes “revenue is vanity, profit is sanity, cash is reality”, but for too long
Indian retailers have been too focussed on top line growth. To avoid being distracted
from the most important indicators of success, retailers need to develop a
performance dashboard that incorporates all three aspects of performance and
continually monitor it. The retail performance dashboard developed by Kanvic
incorporates key lagging indicators like sales, profitability and cash flow, as well as
leading indicators that can give an early warning on future performance. These
leading indicators can include customer and employee satisfaction levels as they have
a direct relationship with sales.
In conclusion, given the current scenario of low gross margins and the combined
threat of economic uncertainty and new market entrants, Indian apparel retailers
must take immediate action to strengthen their business models. They can do this by
improving the business economics, getting the growth strategy right, stress testing
the business model, making the right entry decisions, demonstrating boldness in
exiting non viable stores and product categories and looking at the right performance
metrics.
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EVOLUTION OF INDIAN
APPAREL RETAIL

Evolution of Indian apparel retail
The contentious debate around organised retail in India in recent years has focussed
on the threat the modern trade might pose to the country’s large population of kirana
stores (traditional small scale retailers). While these concerns have delayed and
complicated efforts to modernise retail in categories like food and grocery, apparel has
risen to gain the highest share of organised retail with little controversy (Exhibit 1).
This rapid expansion has been driven by customers’ increasing need for convenience
as they looked to switch from tailored to ready-made garments, as well as the efforts
of the early movers in the apparel retail space.
Apparels have the largest share of organised retail in India
10 20 30 40 50 600
5
10
15
20
25
30
35
Share of total retail
ShareoftotalOrganisedretail
Food &
Grocery
Apparel
Mobile & Telecom
Food services
Jewellery
Consumer electronics
Footwear
Pharmacy
Exhibit 1Category share of retail, 2012, percent
Note: Size of the circle represents the size of total retail market for the category. Others include health & beauty services, furniture, home furnishings, catering
services, books, music, gifts and entertainment services.
Source: Images retail, Euromonitor, AIOCD, Kanvic analysis
Others
The seeds of today’s modern apparel retail industry were sown in the 1990s during
the process of economic liberalisation, when a new breed of modern retailers like
Shoppers Stop, Pantaloons, Trent and Lifestyle opened stores in different parts of the
country. This period also saw the development of India’s first shopping malls. Starting
with Crossroads in Mumbai and Ansal Plaza in Delhi in 1999, the arrival of this new
retail environment transformed the experience for consumers and created a new
platform for the growth of modern retailers.
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Whilst the first phase of growth in apparel retail was driven by the convenience of the
ready-made garments, the next driver was the introduction of a superior retail
experience to what was available in the unorganised sector (Exhibit 2). Air conditioned
stores, uniformed sales staff, and organised store layouts gave the consumer a wholly
new experience. However, these basic in-store improvements quickly became the
norm. In order to achieve the next level of growth, retailers introduced lower price
points to bring a wider group of consumers into their reach.
Apparel retail industry has evolved as a result of distinct drivers of growth in
each of the past decades
Pre 1990 1990s
Convenience
Experience
Price
2000s
•Tier 3 and Tier 4 cities
•Online retail
•Product differentiation
•Extreme low prices
•Availability
•Fit
•Air-conditioned stores
•Attractive
merchandising
•Well groomed staff
•Affordability
•Accessibility
2010s
Driversofgrowth
Source: Kanvic analysis
?
Exhibit 2Evolution of Indian apparel retail
Spotting this opportunity to grow through increasing affordability, a number of deep
discount retailers quickly came to the fore, promising low prices at a fraction of the
advertised MRP (maximum retail price). The initial response from Indian customers
was emphatic, dramatically expanding the customer base. And in response to this
early success, apparel retailers quickly opened hundreds of new stores in smaller
cities where organised retail hadn’t yet penetrated. Investors grew excited by the
potential returns and a number of private equity deals and IPOs provided further
capital for expansion.
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Kanvic analysis of private equity activity in retail shows that apparel received more
than half of the total number of deals in the sector between 2000 and 2009, a period
of high growth for Indian retail (Exhibit 3). It also accounted for 60% of the total
number of deals across the textile and apparel value chain during the same period.
Apparel retailers have received a majority share of the private equity deals in
both the retail industry as well as in the textile value chain
47
53
42
58
Apparels
Non apparels
Apparel
retail
Textile
manufacturing
Note: Deals included are those which concluded between 2000 and 2009, a period of high growth for apparel retailers
Source: VCCEdge, Venture intelligence, Kanvic analysis
Exhibit 3Private equity deals in retail industry,
percent
Private equity deals in textile value
chain, percent
100% = 100% =129 117
After a period of investment and rapid growth in the early 2000s, India’s apparel retail
industry hit severe turbulence in late 2008 with the onset of the global economic
crisis. The slowdown that followed exposed clear weaknesses in the business models
of apparel retailers as many players sold their business, closed down or scaled back
their operations.
In the next chapter we analyse the reasons for the failures in apparel retail during the
crisis and then dig deeper and ask why weaknesses still persist among many of the
survivors.
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THE ELUSIVE SUCCESS
OF APPAREL RETAIL IN
INDIA

Successful business models remain elusive
The first decade of the twenty-first century was a turbulent one for India’s apparel
retail industry. In a few short years many of the industry’s brightest stars rose and
quickly faded into oblivion, while others were dimmed under the burden of heavy
debts.
Although India’s organised apparel retail was worth some $11.3 billion in 2012 and
has grown at over 12% CAGR over the last 5 years (Exhibit 4), players are still
looking for a winning formula to establish a successful and robust business model.
As a starting point for this report we looked back at the pre-crisis point of 2008 and
identified the top 40 Indian apparel retailers ranked by the retail space they occupied
at the time. We then tracked their fortunes through the crisis to 2013 to see how they
have fared.
Our analysis (Exhibit 5) shows that retailers controlling over 30% of the total apparel
retail space in 2008 were forced to either close down or sell their business.
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Furthermore, retailers accounting for another 22.4% of retail space in 2008 can be
classified as struggling. That means they are either suffering losses, scaling down
their operations, or actively looking for an exit.
From the pre-crisis peak, retailers representing less than half of the total retail space
in 2008 have survived and been able to improve their business performance over the
last 5 years, on major indicators such as like-to-like sales, EBITDA1
and inventory
turn.
However, even among these survivors, we have found that the business models of a
majority of players are not sufficiently robust to withstand future crises or deliver
sustained profits in an increasingly competitive environment.
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1 EBITDA - Earnings before Interest, Tax, Depreciation and Amortisation

The causes of failure
We first focussed on the root causes of the high failure rate during the period until
2013. Our analysis found that it was the result of two inter-related factors: the pursuit
of high risk growth strategies and a crisis of leadership at apparel retailers.
High risk growth
Enthusiastic entrepreneurs rushed into apparel retail in the first years of the new
millennium, inspired by the clear market opportunity and a motivation to establish
themselves as leaders in the game. At the same time the availability of private equity
cash in the industry and a number of high profile IPOs created an appealing prospect
of substantial short-term rewards. And looming ever larger on the horizon was the
seemingly inevitable arrival of Foreign Direct Investment (FDI) from global retailers,
promising an even bigger pay day.
In such a climate the ‘animal spirits’ of entrepreneurs took hold, as they sought to
match or outstrip the growth of their peers to emerge as leaders. Any doubts about
the risks of such rapid growth were dispelled by a belief that the deep well of
untapped Indian consumers and the deep pockets of investors would see them
through to a profitable outcome. As a result, many apparel retailers developed
business models that would deliver the fastest top-line growth and capture the largest
market share, for which they believed investors would reward them handsomely.
Such fast growth demanded rapid new store openings and accelerated conversion of
consumers from the unorganised sector. In response to this need, the phenomena of
deep discounting gained popularity among a key group of fast growing apparel
retailers. Their approach elicited early success as shoppers flocked to buy aggressively
priced products in the new modern retail stores. At one of the largest deep discount
retailers, newly opened stores had to temporarily close their doors to control the
inflow of customers.
This initial success was seen as a validation of the business model and other players
were quick to join the fray as valuations and investor interest grew. The arrival of new
entrants further accelerated the push for store expansion as it brought the importance
of location to the fore. With a scarcity of space in India’s cities, retailers saw a direct
relationship between future market share and control of prime retail real estate. Thus,
securing the best locations sooner rather than later became the priority, as retailers
sought to lock in lower rentals today as well as block future competition.
However, funding such rapid growth required additional funds as retailers could not
generate the necessary cash flow from operating activities (Exhibit 6). In the last six
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years the industry’s cash flow from operations could only fully cover the investment
requirement in one year.
As a consequence, many apparel retailers took on high levels of debt to fund their
growth. Our analysis of those companies who suffered during the crisis shows they
had an average debt to net-worth ratio of 1.05 to 1 whereas the average for those
who survived it was only 0.33 to 1 (Exhibit 7). This clearly shows the impact of high
debt on undermining sustainability .
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Other retailers pursued the less capital intensive route of scaling up through
franchisees. But in order to quickly sign up large numbers of partners many adopted a
minimum guarantee model. This promised the franchise holder that his store costs
would be met as well as providing a minimum level of income. This minimum
guarantee model created significant downside risk for retailers who would have to
subsidise loss making stores.
In both debt driven expansion and the minimum guarantee, retailers were taking the
view that revenue growth was all that mattered today and achieving profitability could
be worried about later.
The effects of the economic slowdown that struck in 2008 quickly exposed the flaws of
such a high-risk growth strategy. Slowing sales left many unable to service crippling
debt repayments, pushing them into restructuring or sale.
Confounding these problems were unanticipated regulatory and policy decisions. For
example, in the Union Budget for 2011-12 the optional excise duty levy was changed
to a mandatory levy at a unified rate of 10% for branded garments with an abatement
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of 55%. This hit the retailers offering year round discount of 50% to 90% the hardest,
because of the large difference between their Maximum Retail Price (MRP) and actual
sale price, effectively rendering the deep discount model unviable.
A Crisis of Leadership
The second major contributor to failure in the apparel retail industry was the crisis of
leadership at the top of many organisations. This was crystallised in three critical
shortcomings: linear growth assumptions, overconfidence, and a lack of management
bandwidth.
i) Linear growth assumptions
The working assumption of many leaders in the apparel retail industry was one of
uninterrupted linear growth, a seemingly inevitable consequence of the long-term
Indian consumption story. However, in assuming uninterrupted growth retail leaders
had succumbed to the availability bias in their outlook. The availability bias is human
beings’ tendency to give preference to the most recent and widely available
information. This is often the information that is most highlighted in the media or
discussed by our peers.
In the case of apparel retailers they based assumptions on the recent successes in the
industry, using a tiny data set from the very early stages of the sector’s birth to
extrapolate high growth rates far into the future. Their assumptions on industry
growth rates were also based on the very recent performance of the Indian economy,
which had grown at an average of 8.7% per annum from 2004 to 2008.
Assuming non-stop growth, the only perceived challenge, and the one most regularly
cited by retailers, was ‘execution risk’, i.e. how to open as many stores as quickly as
possible and gain a pan-India presence. Therefore, the most important metric of
success became the number and speed of new store openings. As part of our work in
the sector we came across one retailer who mentioned in their initial discussions that
they wanted to grow to 1,000 stores across India in a few years. This was without
having a clear plan or a detailed understanding of the business model for the new
venture.
By assuming uninterrupted linear growth, retail leaders failed to consider alternative
scenarios where growth could decline and then factor this risk into their business
models.
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ii) Overconfidence
The second shortcoming among leaders in apparel retail was their overconfidence in
their own capabilities to run the business as well as their ability to predict external
events.
The rapid early growth of many apparel retailers created a positive feedback to their
assumptions and fed a growing state of hubris. Initial success was seen as a
vindication not only of their bet on the sector, but also of their business model and
leadership capabilities.
Studies have shown that executive hubris often manifests itself in business decisions
relating to growth for its own sake, acquisitions, and the disregard for rules2
. In the
case of Indian apparel retail, leaders further raised their goals for store openings and
accelerated the speed of expansion, entering into an increasingly incredible contest to
announce more ambitious plans than their competitors. In our analysis of an annual
report of one large retailer, we found that the term “aggressive” was used in relation
to their strategy seven times in 2007-08 while it was not used at all in 2011-12.
Furthermore, apparel retailers made similarly overconfident predictions about the
imminence of major foreign direct investment (FDI) in the sector (Exhibit 8). Yet this
was dependent on important policy decisions by the Government of India, a policy
process over which they had little or no influence and which has a long history of
stop-start activity. Flowing from this was an equally overconfident belief that
international retailers would pay a large premium to acquire immediate scale in the
Indian market. Further assuming that they would have little concern for the
underlying profitability, operational efficiency, or risk profile of the business.
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2 Kroll, M.J., Toombs, L.A. and Wright, P. (2000), “Napoleon’s tragic march home from Moscow: lessons in
hubris”, Academy of Management Executive, Vol. 14 No. 1, pp. 117-28

These displays of executive hubris should have been seen as a warning signal that the
organisation’s leadership was losing touch with reality. In recent research on the
subject, the language of a chief executive at a European bank that went from boom to
bust was analysed to track his rising hubris. During the boom years it was found that
he attributed an increasing amount of the good news about the firm to himself
personally, less to the company and very little to external factors. By contrast no bad
news was attributed to himself or the company.3
In reality, the early successes of many Indian retailers had little to do with the
strength or uniqueness of their business models - which were often value destroying -
and more to do with a short-lived first mover advantage.
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3 Brennan, Niamh M., Conroy John P.; “Executive hubris: the case of a bank CEO”, Accounting, Auditing
& Accountability Journal, Vol. 26 No. 2, 2013, pp. 172-195

iii) Management bandwidth
As Indian apparel retailers began to achieve significant scale, the organisational
complexity multiplied, but many retailers lacked the management bandwidth to
effectively run their companies. With control often concentrated in a small group of
promoters, there was an absence of professional managers at the head office and at
the store level. As a result, the companies’ leadership struggled to get a handle on the
growing risks to the business.
Many of the Indian promoters running apparel retail businesses tended to rely on gut
to power their organisation. Retail leaders believed that they alone could manage a
large-scale operation, which in turn resulted in a lack of appropriate hiring and a
strong degree of micromanagement. Furthermore, the habit of depending on informal
networks of advisers with ambiguous roles was characteristic of the traditional way of
retailing. Practices like this served to undermine the process of professionalisation,
which is an essential element in the modernisation of retail.
Often it was only after pressure from external investors or the realities of a crisis that
promoters moved to hire professionals. However, without the appropriate
management structures and systems in place these individuals were not able to
perform to their potential.
Clearly hindsight offers advantages when explaining the failures in Indian apparel
retail, but identifying the root cause is an essential exercise in addressing the
weaknesses that still persist in the industry, as we will address next in the report.
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The weakness of surviving business models
Although a large number of players in Indian apparel retail sold out, shut shop or are
still struggling, a significant group have survived with their ambitions humbled but
their businesses largely intact. Whilst their survival indicates a relative degree of
strength, a closer analysis of these companies shows a prevailing weakness in their
business models that raises questions about their long-term profitability - and
ultimately their viability.
By benchmarking the top listed Indian apparel retailers against global leaders, Kanvic
has found that after over 20 years of organised apparel retail, none of the existing
business models have been able to achieve margins on a par with the international
leaders. On the key benchmark of EBITDA, which allows comparison of operating
performance across companies irrespective of their financial leverage and investment
intensity, India’s top apparel retailers achieve less than half the figure of the top
global players (Exhibit 9).
Indian apparel retailers have weak business models as a result of higher cost of
sales compared to successful global players
24.0
15.6
7.9
9.4
13.7
10.9
9.9
9.9
8.3
16.1
12.3
5.4
40.5
48.4
67.5
Note: For Indian retailers, figures are averages from 2010 to 2012 for seven leading apparel retailers listed on the stock market. For Uniqlo and ZARA, the
figures are averages for the same period.
Source: Companies annual report, Kanvic analysis
Exhibit 9Benchmarking of Indian retailers’ profit model
with leading International players, % of sales
Cost of
goods sold
Employee cost
Rent
Other costs
EBITDA
Indian
retailers
ZARAUniqlo
Gross margin 32.5 59.551.6
While rents are projected as the main cause of
retailers’ woes, our benchmarking of leading
listed apparel retailers with the global leaders
shows their average rents as well as
overheads are much lower than the global
leaders
Our analysis clearly shows that lower gross
margin (as a result of higher cost of goods
sold) is the root cause for Indian players’
weak and unsustainable business model
As a result of higher gross margins, global
players have 2-3 times the EBITDA margins
compared to Indian players in spite of higher
overheads
34

A common explanation for the underperformance of the Indian retail sector is that
rentals in India account for a higher percentage of total sales. While indeed rent as a
percentage of sales has more than doubled over the last 7-10 years for some leading
apparel retailers, Kanvic analysis shows that rentals for Indian retailers account for a
lower percentage of revenues than more profitable international players like Zara and
Uniqlo.
Certainly, the combination of rising rentals with increasing employee and energy costs
has negated some of the economies of scale Indian retailers may have expected to
benefit from with expansion. But, despite these factors, overall operating expenses for
the leading Indian players are still lower than the most successful international
retailers. Most notably due to the substantially higher employee costs in other
countries.
What all of this clearly shows is that operating costs - and rent more specifically - are
not the cause of the low margins and weak business models in Indian apparel retail.
The real cause of their weakness is low gross margins.
The root causes of low margins
Having established low gross margins as the critical issue in Indian apparel retail, we
then focussed our analysis on identifying the root causes. Our findings show that
these root causes come down to poor supply side economics and retailers’ weak
position relative to customers.
i) Poor supply side economics
On the supply side, the margins of Indian apparel retailers are being squeezed by the
fragmented and inefficient nature of the Indian garment industry and retailers’ weak
bargaining position relative to fashion brands. A critical success factor for the leaders
in global apparel retail has been their relentless focus on and command of their supply
chain. This has enabled them to get the latest trends to market faster and at a lower
cost.
In Indian apparel retail the first point of inefficiency we identified is in sourcing. The
majority of players are sourcing product domestically. Here, in terms of labour, power,
construction, and land transportation, India is a more expensive manufacturing centre
than many of its competitors in the global apparel trade. By comparison, leading
international apparel brands seek out and source their products from the lowest cost
suppliers globally, including Bangladesh and China (Exhibit 10).
35

Indian retailers by contrast are burdened by the inefficiencies of a highly fragmented
domestic supplier base. There are over 100,000 garment units in India4
but most of
them are small and using low levels of technology. Their inefficiency is then passed on
to the retailers in higher prices.
The fragmented supplier scenario in India also results in lower economies in the
purchase of fabrics and other raw materials, further increasing the cost of goods sold.
By contrast, global brands achieve supply chain efficiency through their scale, placing
large standardised orders with large organised suppliers.
Finally, India’s small and often loss-making garment manufacturers have little ability
to invest in the modern machinery that can reduce time to market and drive down
costs in the long-run. By comparison, the top global apparel brands invest substantial
time and resources in developing and integrating their suppliers, allowing
36
4 Source: Confederation of Indian Textile Industry (CITI)

them to cut lead times, lower costs, and improve quality. Thus their supply chain
becomes an integral part of their competitive advantage.
In addition to the inefficiencies in supply chain, apparel retailers must also deal with
the higher bargaining power of both manufacturers and brand owners. On an average,
domestic manufacturer’s operating margin is 5% higher than exporting firms5
,
showing their ability to take a larger piece of the pie from Indian retailers. At the
same time, the pursuit of forward integration by fashion brands - through the
expansion of their own exclusive brand outlets (EBOs) - is reducing their dependence
on multi-brand apparel retailers, including large retail formats. The resulting high
bargaining power of the brand owners was evident following the reduction in excise
duty in 2013, when brands did not pass on the lower costs to customers while some
retailers went ahead and reduced the prices.
ii) Low price realisation
The second cause of poor gross margins among Indian apparel retailers is their
inability to realise higher prices. This is the result of a low level of bargaining power
with their customers and a high level of mark-downs.
Firstly, retailers have little bargaining power with their customers due to a lack of
differentiation between the competing apparel retailers and high price elasticity
among consumers.
In India, both organised and unorganised multi-brand outlets (MBOs) are usually
selling the same range of branded apparel at similar price points in a barely
distinguishable retail environment. When organised apparel retailers first entered the
Indian market they focussed on differentiating themselves from the unorganised
sector. However, the basic steps like air conditioned stores and a wide range of
products have now become generic - an expected minimum by India’s urban
shoppers. Without a clear differentiation between retailers, customers are unwilling to
pay a premium to that of the lowest priced competitor.
Given the highly value conscious nature of the Indian consumer, high price elasticity is
common as customers actively seek out bargains and discounts. Retailers can combat
this by creating a loyalty system and tracking their loyal customers. However, today
only 20% of Indian apparel retailers get more than 25% of their sales from loyal
customers and a majority (60%) are not even measuring sales from loyal customers
at all (Exhibit 11).
37
5 Source: CRISIL

Sixty percent of retailers do not have a system to measure sales from loyal
customers
Not measured
< 25%
25% - 50% 20%
20%
60%
Source: Retailers Association of India
Exhibit 11Sales form loyal customers, percent of respondents
60%
Globally, players have created differentiation and brand loyalty through delivering a
distinctive style, quality or customer experience that is difficult to find elsewhere. For
example, Zara’s in-house production system continually delivers versions of the latest
fashion to their stores faster than their peers, with the added incentive for customers
that when it’s gone, it’s gone! Uniqlo delivers a less fashion centric offering but with a
quality of fabric that is impossible to find at a better price elsewhere, due to its huge
scale in sourcing and its massive investment in production and textile technology.
Finally, new experience led stores like Hollister’s make large investments in store fit-
outs to draw customers in and increase the likelihood of conversion, in their case
creating an experience that is more like a nightclub than a retail store!
Compounding retailers’ weak bargaining power with customers is the high level of
mark-downs in the sector. This is the product of poor demand management and weak
mark-down management. Poor systems for merchandise planning result in large build-
ups of unwanted stock, necessitating heavy discounting at the end of the season. This
distorts customer expectations on price as well as eroding the retailers’ brand image,
making it even more difficult to command higher prices in the future. Even where
Indian retailers are not suffering from high levels of slow moving stock, they are often
38

forced into mark-downs by their competitors who launch their sale early or extend it
for longer.
By comparison, leading international apparel retailers like Next and Nordstrom
leverage their customer loyalty to make their main sale a recognised retail event. The
dates are fixed from year to year, building a sense of customer anticipation that often
results in queues outside the stores and huge traffic to their web portals.
In today’s scenario Indian apparel retailers are competing increasingly against other
organised players as well as the unorganised sector. As such, the lack of
differentiation in retail experience leaves apparel retailers particularly vulnerable to
both the threat of new entrants and the emergence of low touch channels like online
retail.
With Indian apparel retailers hampered by low gross margins, the imperative of the
moment is to take decisive action to strengthen their business models. In an uncertain
domestic and global economic climate, muddling through with the status quo is not a
sustainable option. In the next chapter, we present six steps Indian apparel retailers
can follow to get on the winning track.
39

EMERGING AS A
WINNER IN APPAREL
RETAIL

Emerging as a winner in apparel retail
To fly through the current turbulence in Indian apparel retail and emerge a winner will
require industry leaders to take a new approach. We have identified six key steps
(Exhibit 12) Indian apparel retailers can follow to get on the winning track: 1) improve
the business economics; 2) get the growth strategy right; 3) stress test the business
model; 4) make the right entry decisions; 5) demonstrate boldness in exiting; 6) look
at the right metrics.
Apparel retailers need to take six key steps in building robust business models
to emerge as a winner in the industry
Emerging as a
winner in
apparel retail
Improve
business
economics
Stress test the
business model
Get the growth
strategy right
Make the right
entry decision
Demonstrate
boldness in
exiting
Look at the
right metrics
1
2
3
4
5
6
Exhibit 12Six key steps for apparel retailers to emerge as a winner
1. Improve the business economics
For too long Indian apparel retailers have been too focussed on top line revenue
growth rather than generating profit. Although some retailers have belatedly shifted
attention to profitability at the store level, it is primarily focussed on sales relative to
rental costs. In fact the high cost of rentals has become the fig leaf which the industry
has tried to hide behind to explain away a lack of profitability. This has distracted
attention from the key drivers of profitability in apparel retail: lowering the cost of
goods sold and achieving higher sales.
43

The most profitable global apparel retailers have created superior business economics
by driving cost out of the supply chain at the same time as delivering a clearly
differentiated customer experience. Such successes have yet to be achieved by Indian
apparel retailers but, by taking action on a number of levers (Exhibit 13) they can get
on the path to improved profitability.
Indian apparel retailers can their improve business economics by acting on both
sales and cost levers
Sales
Cost of
goods sold
•Increasing differentiation
•Shifting from simple push to
push and pull supply model
•Employing better mark down
management
•Improving customer
engagement
•Right sourcing strategy
•Investing in and
integrating the supply
chain
•Increasing the share of
private label
Margin
expansion
Expanding margins through both
increased sales and cost reduction
Exhibit 13
Reducing the cost of goods sold (COGS)
The first front for improving the business economics in Indian apparel retail is
reducing the cost of goods sold. This will be achieved through i) the right sourcing
strategy, ii) investing in and integrating the supply chain, and iii) increasing the share
of private label.
Firstly, Indian apparel retailers need to get their sourcing strategy right. This involves
identifying the best value suppliers whether in India or abroad. For example,
manufacturing costs in neighbouring Bangladesh are 20 percent lower compared to
44

India6
. In 2012 Bangladesh’s total apparel export was $22.2 billion compared to
India’s $12.9 billion7
, resulting in larger scale manufacturers more attuned to
international requirements. In recent years steadily rising garment imports from both
Bangladesh and Sri Lanka show the increasing competitiveness of imported products
versus locally manufactured garments. Imports from Bangladesh and Sri Lanka grew
at a CAGR of 90% and 61% respectively between 2008 and 2012, compared to 23%
growth of total apparel imports during the same period8
.
In addition to making the right sourcing decisions, retailers need to make substantial
investments in their supply chain to improve the speed and quality of production,
which will further lower the costs of goods over time. At present the lead time for
many Indian suppliers is 4-6 months - far too long to respond to changing consumer
trends. But to make the necessary investment in machinery, technology, and systems
requires long-term strategic collaboration with suppliers. These kind of partnerships
will demand commitment, substantial financial investment and a collaborative
approach from the retailer.
Finally, increasing the share of private label products is a critical step to reducing the
cost of goods sold. The most profitable global retailers such as Zara, Uniqlo and H&M
are almost exclusively private label retailers. In a highly competitive market, paying
higher prices to brands is margin eroding and the indirect investment in their brand
dilutes the retailers’ standalone brand equity. Globally, multi-brand apparel retail is
the domain of premium department stores, online retailers or local boutique stores.
The first can maintain margins due to the high price of the product as well as
commanding rentals for shop-in-shop concessions. Secondly, lower infrastructure
costs allow e-retailers to preserve profit margins. While smaller stores serve niche
local markets and lack the scale to source their own product.
Indian apparel retailers need to develop a clear plan for building a capability in private
label, from developing an integrated supply chain through to better understanding
their customers’ needs.
45
6 Source: Fashion United
7 Source: International Trade Centre
8 Source: International Trade Centre

Increasing Sales
The second front for improving the business economics is increasing sales. Apparel
retailers can increase sales on a like-to-like basis by: increasing their sales density
(sales per square foot); protecting their MRP price; and gaining a capacity to increase
prices without a reduction in volumes. To achieve these objectives Indian apparel
retailers need to focus on four key areas for improvement: i) increasing their
differentiation, ii) switching from a simple push to a push and pull supply model iii)
employing better mark-down management and iv) improving customer engagement.
i) Increasing differentiation
When the product and experience are weakly differentiated from other players
competing in the same segment, the customer will only compare in terms of price.
Thus when one player discounts to shift slow moving stock or increase sales, the other
players are forced to follow suit, destroying value across the sector. This is the
prevailing scenario in Indian apparel retail.
To effectively differentiate, retailers need to deliver a unique combination of product
offering, price point, and customer experience. But to do this they first need to decide
in which customer segment they want to play, and then develop the proposition that
will be most highly valued by these customers. Today Indian retailers have yet to
effectively target discrete customer groups, with most offering a largely generic range
of mens western casuals and formals. But as the Indian consumer market becomes
increasingly fragmented, customers are looking to express themselves in distinct
ways. In such a scenario continuing to try and be all things to all people is a recipe for
failure.
For example, an older customer that buys according to quality and customer service is
likely to be unsatisfied by a store that promotes fashionable items on young models
and is staffed by young attendants. Alternatively teenagers and students looking for
casual wear will be put off by extensive floor space dedicated to office wear and older
attendants dressed in formals.
But being targeted doesn’t mean that the retailer remains small. Zara is a multi-billion
dollar enterprise but clearly focusses on a younger fashion conscious consumer with
its core format, developing other concepts like Kids or distinct brands like Massimo
Dutti (luxury) for other segments. Similarly Uniqlo’s single format model ignores the
highly fashion conscious consumer and focusses on those who value great
functionality and affordability in their garments.
46

Critical to achieving a differentiated positioning is its consistency across every aspect
of the customer experience; from the look and feel of the stores, to the level and type
of customer service and the convenience of the channel.
However, in transforming a unique strategic positioning into a truly differentiated
experience, the moment of truth is the customer interaction with the retailer’s staff on
the shop floor. Store staff are vital to converting walk-ins to customers, cross-selling
new products and upgrading them to higher value purchases. What is more, they
acquire numerous insights on customer behaviour and feedback that are invaluable to
the organisation. All of this is critical to the achievement of higher sales.
The quality of the customer interaction is a persistent area of weakness for Indian
apparel retailers and a great opportunity for players to achieve differentiation. With
staff representing a low percentage of total expenditure and the high availability of
low skilled labour in India, this critical component of a retail organisation is treated on
a commodity-like basis. The inevitable result is low employee engagement and high
attrition rates, with retail managers and store staff trapped in a cycle of mutual
dissatisfaction. The net effect are false economies in operating costs that actually
mask a mountain of lost sales and unhappy customers.
Tackling this weakness requires appropriate organisational design, proper internal
communication and decision-making systems, incentive programmes that recognise
success beyond simple financial rewards, and meritocratic models for promotion that
reward loyalty to the organisation over the long-term. These systems and processes
need to be transparent and supplemented by ongoing training and development at the
store and head office level.
ii) switching from a simple push to a push and pull supply model
Apparel retailers need to move away from the current practice of push based supply
to a more intelligent system of push and pull. Today many retailers are waging an ‘all
in’ bet on the next season by placing their complete orders in advance. The
impossibility of accurately predicting the next season’s fashion trends, weather, or
consumer confidence, inevitably results in slow or non-moving stock that must be sold
at discount, bringing down the gross margins.
Instead, retailers should break the season down into shorter periods and break the
product range down into different categories according to their predictability. For
example, by breaking the season down into shorter planning cycles, retailers can
continually test the customer response to say a style or colour and place further
orders accordingly for the next ‘mini’ season. As a result the downside of a bad call in
merchandise planning is limited to a much smaller amount of stock.
47

These shorter planning cycles should be supported by a clear break-down of the
product range according to their fashion quotient. For example, a simple segmentation
could be into basic, basic fashion and fashion items. These categories are defined by
whether their predictability of demand is high, medium or low. For example, basic
items like simple white shirts, t-shirts and inner wear might see very little variation in
demand from season-to-season. These items can be ordered further in advance and in
larger quantities. As the fashion quotient increases, the more fickle the customer
response will be. Therefore more fashion oriented items should be ordered in smaller
quantities with shorter lead times, giving planners sufficient wiggle room to adjust
their orders.
To implement shorter and more agile planning cycles retailers must create dedicated
internal planning teams that are constantly monitoring the latest global and Indian
trends. There also need to be systems in place to regularly communicate information
back from store staff and customers to inform these planning decisions.
iii) employing better mark-down management
Even when inventory is under control, Indian retailers can fall into the trap of marking
down prices due to pressure from competitors, producing a negative impact on
income. Whilst a strongly differentiated value proposition will help persuade
customers of a brand’s superior value, retailers need to maintain discipline in mark-
downs to protect their margins.
Key to mark-down management is having a proper mark-down plan in place ahead of
the season. Retailers should consider in advance which products they are willing to
discount and by how much. This should be integrated with their financial planning for
the season, so they are fully aware of the implications of mark-downs on their
profitability at both the chain and category level.
Secondly, retailers need to be proactive in their use of mark-downs to avoid having to
clear large amounts of stock at the end of the season. If a line is selling slowly,
incremental price reductions in-season can help clear inventory, without the need for
aggressive sales across all products lines at the end of the season.
Finally, planning the dates for your major yearly or twice yearly sales and building a
marketing plan around them will help optimise the mark-down process. Retailers can
project the amount of discounts and the likely uptick in sales volume and thus
estimate an appropriate marketing budget to invest during the sales period. Well-
planned and executed sales can actually drive profitability through dramatically
increasing volumes at key points of the year. By combining effective marketing
communication about the sale with attractive discounts targeted at loyal shoppers,
48

sales can also become a valued element of your proposition to your most profitable
customers.
By employing these techniques sales are no longer a necessary evil but an integral
part of the retail strategy, contributing to both profitability and customer excitement
about the brand.
iv) Improving customer engagement
While a clear differentiation will attract customers to the brand, retaining and
upgrading them requires retailers to engage them in a targeted way. Here measuring
customer loyalty is an essential first step which many Indian retailers have yet to
take. But managing loyal customers must go beyond simply issuing cards and giving
points. Loyalty programmes need to be used to identify and segment the most loyal -
and profitable - customers. They then need to be given interesting targeted offers and
services. As retailers grow their capabilities in loyalty management, analytics become
a powerful tool, enabling them to send highly personalised offers to individual
customers according to their recent purchase behaviour.
These technology based loyalty tools are insufficient though, if they are not supported
by the right actions of store staff at the critical moment of truth. In our research
conducted at a number of national retailers (Exhibit 14), we witnessed how store staff
regularly missed opportunities to engage customers and convert walk-ins into billings,
and how in some cases they even alienated and offended their clientele. Addressing
these ‘break points’ by training staff in the correct techniques for customer
engagement will significantly increase conversions and customer satisfaction.
Furthermore, the most loyal customers must receive enhanced service by store staff
and managers or else they will remain underwhelmed. In this regard lessons from the
hospitality and travel industry are particularly valid, where top airlines and hotels
ensure their staff are fully briefed about the personal preferences and requirements of
their most loyal customers, enabling them to give them special recognition and
treatment.
49

Our research at a number of retailers shows how a ‘break point’ during
moments of truth results in missed opportunities to engage customers
Company Format
Moment of
truth ‘break points’
Better way to engage
customers
National retail
chain - A
LRF
•Heated argument between
customers and salesman
reaching to the point of
salesman nearly hitting the
customer
•Intervention by another
sales manager before “flare
up”
•Just apologise
National retail
chain - B
EBO
•Store manager says ‘No’ on
asking for a shirt availability
•Goes back to computer and
pays no attention as the
mystery shopper browses
products
•Offer similar products if
available
•Show interest in customer
while she is browsing
National retail
chain - C
EBO
Store manager says “Store
closed” as the mystery shopper
walks in
•Ask for customer
requirement
•Take down contact details
LRF - Large Retail Format, EBO - Exclusive Brand Outlet
Exhibit 14Ways to engage customers during
moments of truth
2. Get the growth strategy right
Retailers achieve growth by either increasing sales from existing stores or opening
new stores. While the former calls for sales productivity (usually measured in sales
per square foot), the latter requires a deep understanding of the local market to get a
clear picture of its retail potential and to identify the right locations.
Until now most Indian apparel retailers have achieved growth by opening more new
stores rather than making existing stores more profitable. The future imperative is to
find the optimal balance between store expansion and sales productivity that will be
sustainable under different economic scenarios.
Kanvic has developed a proprietary model for retail growth strategy that captures
these critical aspects. The model’s key inputs in determining the future growth
strategy for a retailer are their current profit levels and the degree of financial
leverage in the business.
50

In the example modelled below (Exhibit 15), we consider two retailers (based on
actual cases9
) pursuing different growth strategies under two different economic
scenarios - normal growth scenario and slowdown scenario. Retailer A is increasing its
number of stores by 20%10
year-on-year while Retailer B is increasing them at a
slower rate of 10%. While Retailer A has a cash profit margin11
of 3.9%, Retailer B is
more profitable at 4.5% in the first year. Retailer A also has a higher debt to equity
ratio of 1:1 compared to Retailer B’s 0.5:1.
The current profit model and the amount of financial leverage help decide the
right growth strategy under different sales scenarios
Revenue
Cash profit,
percent
Margin of safety,
percent
Debt/Equity ratio
Base model
100
100
1.0
.50
Normal growth
scenario -
10% LTL growth
2.24
.54
2.56
.55
Slowdown
scenario -
0% LTL growth
110
106
-0.7
2.24
.53
122
115
-1.9
1.3
-10.0
2.4 .66
Note: LTL - Like to Like Sales growth is growth in sales of stores which have been operational for more than a year. Cash profit is profit after tax plus
depreciation. Assumed that only 50% of the cash profit of the previous year is used as equity for expansion. Sales from new stores is assumed 50% of the
existing store sales for retailer A and 60% for retailer B in the year of opening. Margin of safety is a percentage of break even point.
Retailer A, adds 20 new stores every year Retailer B, adds 10 stores every year
Exhibit 15Modelling scenarios under different levels of growth and leverage
Y1
Y2
Y3
Y2
Y3
120
116
143
136
3.9
4.5
2.5
4.4
1.9
4.9
0.6
2.6
14.6
17.8
17.7
7.7
4.9
20.9
3.28
8.0
We then model the performance of these two retailers under a normal growth scenario
that sees Like-to-Like sales grow at 10% in years 2 and 3, and then under a
slowdown scenario that sees Like-to-Like sales growth at 0% in years 2 and 3.
51
9 The current profit model of two retailers is taken as a basis to build our growth strategy model. Our
assumptions include 5% escalation in fixed costs, interest at 12% and the debt repayable in 5 years.
10 Measured on the total number of stores at the end of Year-1 (Y1)
11 Cash profit is calculated by adding back depreciation to profit after tax.

Under the normal growth scenario Retailer A sees its revenues grow 43% by year 3
but its profitability approximately halves as a result of pressure from new stores. This
reduces its margin of safety by 60% and increases its debt to equity ratio two and a
half times.
By contrast, Retailer B who pursued more balanced expansion, sees its revenues grow
more slowly at 36% but its cash profit margin increases to 4.9%, and its margin of
safety rises to more than 20%.
The most dramatic contrast in fortunes comes however during an economic slowdown.
In this case Retailer A’s revenues only increase 22% by year 3, turning its cash profit
negative and completely eroding its margin of safety. As a result its debt to equity
ratio balloons further to 2.9:1. Retailer B’s more thought out strategy pays off here,
with its revenue growing marginally less at 15% over 2 years but it is able to retain a
modest profit margin. Its greater margin of safety also allows it to keep its debt to
equity ratio at a manageable 0.66:1.
This example clearly illustrates the predicament that many Indian apparel retailers
found themselves in after pursuing aggressive growth strategies with a highly
leveraged balance sheet and low profit margins. By modelling their growth plans
under such different scenarios, retailers can ensure their future growth strategy has
the right balance between sales productivity and new store openings, providing a
sound footing for sustainable growth.
3. Stress Test the Business Model
Many of the problems that beset Indian apparel retailers were the result of a blinkered
view of the external environment and wild assumptions of future growth. In boom
times we can be quickly deceived by the consensus opinion that tell us things will only
get better. Taken in by this euphoria, many retailers believed their business models
would succeed indefinitely, whereas in reality they were incredibly fragile. In order to
build resilience to future shocks, retailers need to stress test their business models
against a range of different scenarios.
The first step in stress testing is for managers to prepare a baseline business plan
using their current assumptions. They should then develop optimistic and pessimistic
scenarios and assess how the model performs under the new circumstances. If the
pessimistic scenario produces losses, they then need to analyse for how long they can
meet their fixed costs and any debt repayments should such a scenario persist.
While many large retailers have developed their business plans with optimistic and
pessimistic scenarios built in, the sensitivity analysis of the key business variables is
done with only incremental changes in these variables. This leaves a situation like the
52

2008 global financial crisis out of sight. To really prepare themselves for future
uncertainties, retailers need to stress test their business models under ‘extreme’ but
probable scenarios, not with a series of minor or incremental tweaks. Such testing
may involve inputs such as like-to-like sales ending in a negative territory or the key
costs spiralling over a short period of time. In addition to internal business variables,
retailers also need to test their business models for key external assumptions e.g.
policy decisions getting delayed in unanticipated ways.
Furthermore, it is important that such stress testing is conducted by people who are
emotionally detached from the current business strategy and are able to factor in
future scenarios more objectively. This ‘outside in’ approach helps in revealing the
potential blind spots and testing the business model for future shocks in the economy.
This kind of stress testing is particularly critical before adopting major strategic
changes such as changing the store format or switching to a new business model. It is
important to note that the real value of stress testing is much more in going through
the process than in trying to predict the future.
Once the performance of the business model has been assessed and the key risks
identified, the company then needs to decide what measures it can take to mitigate
them. For example, given the future performance under ‘extreme’ scenarios, retailers
could take a more measured approach to growth or they might improve their risk
profile by altering their leverage.
It is also possible to run with the same business model but build in risk mitigation to
deal with future downturns in the business. For example, one mid-sized Indian
apparel retailer has created a ‘business fund’ of Rs. 10 Crores that can be deployed in
case of a serious downturn.
4. Make the right entry decisions
Choosing when and where to enter a new market is critical to retail success. A large
number of retailers have tied themselves into undesirable locations and unsustainable
rentals on the basis of aggressive expansion targets and speculation about future
trends in the real estate market. However, by ignoring the market realities of specific
locations retailers have put their sustainability at risk.
Before committing to a new store location retailers need to first assess the overall
demand and supply scenario in the given geography to understand its broad potential.
As retailers opened their first stores in the metros and large Indian cities, these
locations have reached various levels of saturation in supply across different product
categories. For example, Pune has an oversupply of retail space, creating tough
competition among incumbents. Any new entrant will face major resistance in this
53

market and will find it difficult to generate the expected sales until the retailer offers a
really unique value proposition. On the other hand, the attention to new growth
markets in tier 2 and tier 3 cities has not delivered the expected results. Bikaner, a
smaller city in Rajasthan is under-penetrated and under served for apparels but the
existing players seem to have a complete disconnect with the local customers and
their preferences. This leaves the opportunity wide open to nimble regional players
and local MBOs.
After deciding on the city, retailers must then drill down and assess the attractiveness
of the new market, in terms of the availability of their target customer segment and
the level of competition from retailers in the same strategic group. This will reveal the
micro markets within the city and help decide the right locations. While retailers may
mention ‘location, location, location’ as a key factor for success, they sometimes
overlook the basics in a rush to open stores and have their presence in ‘hip’ locations.
In our work, we came across a large International retailer with over 2,000 stores that
was making location decisions based on a ‘flying visit’ to the city’s latest trendy spots,
without thinking through its target segments and the competition. Such passing
attention to choosing store locations will not help retailers in making stores profitable.
Retailers also need to test the fit of any new location with their existing or planned
store network. Having sufficient knowledge of a particular market and its customer
base and being able to efficiently manage and stock a store is critical to its
profitability.
Here, increasing store density in a specific city or region rather than rapidly jumping
to new part of the country retailers can reap a number of benefits. Firstly, it delivers
greater economies in warehousing and transportation of goods, particularly given
India’s challenging infrastructure scenario. Furthermore, as we have found in our
client work, a close proximity of stores makes it easier to transfer experienced staff to
support new outlets, helping to share knowledge and instil the company culture at the
new location. Finally, achieving higher store density can deliver greater economies in
advertising spend as a single media campaign benefits multiple locations. This is
highly pertinent in India’s strongly regional media market.
Finally, when a retailer is operating a number of outlets serving similar customer
profiles they are able to cluster stores. Clustering allows them to replicate product
mix, pricing, staffing and store design across multiple stores rather than going to the
added complexity and cost of individual plans.
5. Demonstrate boldness in exiting
Closing down a store or exiting a format or category may seem like defeat, but
throwing good money after bad can make things much worse. Store closures are
54

common phenomena, even among the most successful global retailers, as local
markets fluctuate and company priorities change (Exhibit 16).
In India, retailers have been particularly reluctant to exit store locations due to fear of
having to pay higher rentals in the future. Yet to succeed retailers need to maintain a
determined focus on store level profitability. To help maintain this focus retailers must
track actual sales versus projected sales and realistically forecast the time to break
even. This will bring the store’s viability into sharp relief.
But before taking a decision to close a store, retailers should drill down to identify
other possible reasons for low sales. Here staff can have a dramatic impact on a
store’s performance. In our experience with an Indian apparel retailer, changing the
team at an under-performing store saw sales increase by 57% in the first quarter of
2013-14 over the same period last year.
The ability to quickly exit a loss-making position applies to product categories as well
as stores. A number of apparel retailers have sought to grow revenues by adding
more product categories like womenswear and kids wear, or extending into formal or
55

casual wear. While increased product categories can appeal to more customer
segments, it also adds considerable complexity to the business. Retailers who have
yet to master merchandise planning or establish a strong brand in their core category
take a considerable risk by branching into new ones.
Those who have already diversified should assess the synergy between categories in
terms of the customer needs and the supply chain. Categories that are found to be
persistently slow moving and that have little impact on drawing target customers to
the store should be discontinued. As should those that offer inferior profit margins.
We have however seen that retail leaders tend not to exit loss-making stores or
categories, even when the prospects seem rationally clear. The reason behind such
inaction is human nature to be loss averse. Academic research has shown that a loss
has typically two and a half times the impact of a gain of the same magnitude12
. Yet
retail requires decisions that are detached from our emotions. Exiting promptly can
stem losses and allow resources and attention to be focussed on more profitable parts
of the business where they can be more productively deployed.
6. Look at the right metrics
As the saying goes ‘revenue is vanity, profit is sanity, cash is reality’. Indian apparel
retailers have been too focussed on sales as their measures of success, forgetting
profits and cash.
To avoid getting distracted from the most important indicators for their business,
apparel retailers need to develop a performance dashboard (Exhibit 17) that
incorporates all three aspects of performance and continually monitor it. This will give
retail leaders immediate visibility of company performance and allow them to track
changes on a continuous basis, highlighting potential problems long before they
become critical.
In our work with retailers we have helped them institute profit measurement from day
one. The key profitability metrics to track are the costs, sales and profit margins at
the chain, store, and category level. Retailers can also learn from best practices in
other industries. For example, hospital group Narayana Health communicates
revenues, costs and EBITDA to its senior management by mobile messaging every
day.
56
12 Daniel Kahneman and Amos Tversky, “Prospect Theory: An Analysis of Decision under Risk”,
Econometrcia; Mar 1979; 47, 2

A performance dashboard covering key indicators of business success can prove
to be an invaluable tool in tracking performance and taking corrective actions
Source: Kanvic
Exhibit 17
Store A
Store B
Store C
Store D
Store E
798
865
890
945
980
1110
1235
Store F
Store G
Window shoppers
100
Walk-ins
70
Walk outs
28
Shoppers
42
Customer satisfaction
Employee satisfaction
Apr May Jun Jul Aug Sep
100
108
66
78
92
110
Loyalty sales, index = 100
Inventory, no of
days of sales
129.4
Sales per sq. ft per
month, Rs
Customer Conversion funnel
Gross profit
margin, %
32.9
Operating cash
flow, Rs. Crore
-132
Apr May Jun Jul Aug Sep
596
713
500
548
673
885
Loyalty card registrations
Performance dashboard for an apparel retailer
In addition to profitability, retailers need to pay close attention to their cash flow.
Monitoring how much cash is being generated from current operations and what the
additional requirements are to finance growth will help retailers avoid a cash crunch
scenario. A negative cash flow puts exceptional pressure on a retailer, as they must
meet the current shortfall as well as the funding requirements for future investment.
For retailers cash flow is a direct consequence of inventory turn, so being able to track
the current rate of turn at the aggregate and category level will flag up a potential
drain on cash.
As well as lagging or backward looking indicators like sales and profitability, apparel
retailers also need to incorporate leading indicators that give early warning signals on
likely future performance.
Leading indicators include the level of customer satisfaction, measured for example by
the number of customer complaints. If there is a deviation from the norm,
management can drill down further to understand the reasons - these could be
product or service related. Tracking average ticket size will also give an indication of
57

customers’ declining propensity to spend, that may have been masked by an overall
increase in the number of customers.
A precursor to customer satisfaction is employee satisfaction. Store staff have a huge
influence on sales, and studies have shown that that a minor change in staff
satisfaction has a direct effect on store sales.
It is important to note that chain wide measurement of customer and staff satisfaction
must be supplemented by routine in-store observations from the head office or
regional offices. An index that tracks company wide performance can be of little
practical use unless it flags up areas of weakness that can be practically addressed.
One food retailer in the UK for example used a panel of buttons at the exit in red,
orange and green to allow customers to anonymously and instantaneously give their
feedback at every store.
58

Conclusion
With the profitability of Indian retailers lagging far behind those of international
leaders, some observers and incumbents have concluded that today’s scenario is
unavoidable given the current stage of market development. The claim is that
improved profitability can only come when consumers, competitors, suppliers and
market regulators reach a greater level of maturity. However, such a conclusion is
incorrect. It is formed from observing failures and deducing an underlying structural
problem, as opposed to analysing the flawed strategies and business models retailers
have adopted. While issues like government policies, high rentals and the value
conscious Indian consumer present challenges, they are not the root causes of the
industry’s problems.
Through extensive research and analysis, and our on-the-ground client experience,
this report has shown that the critical factor of low gross margins in apparel retail is
the product of poor supply side economies and a weak bargaining position with
consumers. While requiring concerted action, these challenges are far from
insurmountable. By following the six steps outlined in this report, apparel retailers can
start to build the sustainable business models that will help them fashion a winning
trail into the future.

kanvic.com
Copyright 2013 Kanvic Consulting Private Limited. All rights reserved.
Bangalore
Ravindra Beleyur
M: +91 94481 46963
E: ravi@kanvic.com
Delhi
Deepak Sharma
M: +91 99283 77800
E: deepak@kanvic.com
London
Gehan Wanduragala
M: +44 7825 160716
E: gehan@kanvic.com
Paris
Vlad Flamind
M: +33 76245 1907
E: vlad@kanvic.com

FASHIONING A WINNING TRAIL - How to build sustainable business models in Indian apparel retail

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