Saturday, February 28, 2009

By M H Ahssan



Subhiksha is India's largest retail chain -- or some would prefer to say "it was." Over the past few months, the network of neighborhood discount shops has been coming apart at the seams. Most of the outlets are now closed. The company -- Subhiksha Trading Services -- has been unable to pay salaries and statutory dues for the past few months. With the unpaid security agency staff also not reporting for work, many of the stores have been vandalized. "The properties have become vulnerable targets," founder and managing director R. Subramanian told The Financial Express. The vandals, he said, could include "disgruntled vendors, employees, anti-social elements taking advantage of the situation, and even owners of the real estate" rented by the retail chain.



Subhiksha -- which means "prosperity" in Sanskrit -- is coming apart in other ways, too. In fast-moving developments, one of the investors -- private equity company ICICI Ventures -- has asked the government to step in and order an independent audit of the company's accounts. Another investor -- the high-profile Wipro chairman Azim Premji's personal investment firm, PremjiInvest -- has approached the Madras High Court to stop the proposed reverse merger between Subhiksha and Blue Green Constructions & Investments, a listed company Subramanian had acquired last year. Subramanian's objective was to get listed through the back door after the plan for an initial public offering fell through because of adverse market conditions. ICICI Ventures holds a 23% stake in Subhiksha and PremjiInvest another 10%, which was sold to it by ICICI Ventures last year for around US$50 million. In addition, the Employees Provident Fund Office recently said that Subramanian will be held personally responsible for non-payment of statutory dues to the staff.



Previously, Subramanian was the poster child of India's retail revolution. Others, like the Future Group's Kishore Biyani (who started Big Bazaar, Food Bazaar and Pantaloon) may have made a bigger splash. But Biyani had a business background; Subramanian's father was a Reserve Bank of India official and Subramanian was a first-generation entrepreneur, a product of liberalization and India's answer to Wal-Mart's Sam Walton. "Subhiksha was a value-focused retailer born at a time when organized retailing was only for the elite," said Subramanian in an email to India Knowledge@Wharton. "From 150 stores in September 2006, all of which were in Tamil Nadu [a state in South India], the company grew rapidly to over 1,600 stores [across the country] by September 2008."



The big question: Is Subhiksha shutting down? "We are in pain but we are not shutting down," Subramanian wrote. "We had expanded rapidly; most of the growth was debt-led. The company had planned to raise equity during 2008 and was close to doing so in September when calamity hit the global markets. The company's lenders, while supportive, were also unable to extend further lines unless the equity was raised. The banks were not lending to each other, forget about lending to us.... It became a chicken-and-egg story with the company running out of cash by October. We were making money up to September, so the business is viable; it's just that the balance sheet was not.... Money is like blood. If the blood flow stops, the entire brain stops working."



Subramanian acknowledges that employees, landlords and vendors have not been paid. "It's not because we do not want to pay; it's because we can't pay." Is the Indian retail story over for now? "In a market like this, there will be pain," Subramanian wrote. "However, people with long-term interest in retail and a sane cost structure will survive and thrive. Subhiksha will be there, too."



Lack of Demand

Subhiksha, of course, is not alone in facing a recent reverse. The woes of India's organized retail sector -- or "modern trade," as it is called -- have many causes and casualties. Even well-financed companies or those that have wealthy backers are feeling the heat.



"Lack of demand is the major problem," says Mathew Joseph, senior consultant with Delhi-based think-tank the Indian Council for Research on International Economic Relations (ICRIER). "Real estate prices are falling, and organized retail would like to wait until the bottom is reached. Finance is also difficult to come by in the context of falling demand and low profitability as banks are becoming risk averse." Gibson Vedamani, director of the Retailers Association of India (RAI), adds: "Like everyone else, the business groups in modern retail have been hit by the global recession by way of a credit squeeze [and a lack of] funding and working capital. The slump in real estate has been a big issue. Those who had big expansion plans had [acquired] real estate earlier at much higher prices. They are now re-looking at their expansion plans and renegotiating the rates."



One example is Reliance Fresh, backed by Mukesh Ambani, the world's wealthiest Indian and chairman of Reliance Industries. Ambani considers retail the next big thing both for his group and the country. Reliance Retail, a subsidiary of Reliance Industries, launched its first store in November 2006 through its convenience store format, Reliance Fresh. At the end of the last fiscal year (March 2008), the group had 590 stores across 13 states. (It is close to 1,000 now.) This includes other formats such as Reliance Digital, Reliance Mart (hypermarkets), Reliance Trends (apparel), Reliance Footprints (footwear), Reliance Jewels (jewelry), Reliance Timeout (books, music and other lifestyle products), Reliance Autozone (auto accessories and service) and Reliance Wellness (health and wellness).



There were problems from day one. Vegetable sellers stoned Reliance shops in Ranchi, Jharkhand, claiming their businesses would be killed. There was a dawn-to-dusk shutdown of all major markets in Bhubaneswar, Orissa. In West Bengal, Reliance Retail ceased operations after widespread protests. In Uttar Pradesh, the government ordered the closure of the chain following eruptions of violence and the ransacking of some outlets. In Mumbai, traders, farmers and shopkeepers moved into the streets, bringing the city to a near standstill. They were protesting not just against Reliance, but organized retail as a whole. "This is a do-or-die battle for us. Either they go, or the small traders and farmers perish," says Dharmendra Kumar, director of India FDI Watch, an organization that seeks to prevent Foreign Direct Investment (FDI) in the retail sector in India. Kumar says his mandate is to prevent multinationals like Wal-Mart, Tesco and Carrefour from entering the Indian market. As they are not yet in India -- or are present in very restrictive formats -- companies like Reliance Retail have become the substitute targets.



Much of this battle took place in 2007. Today, organized retail is downsizing by itself. Reliance has reassessed its plans and closed some stores; it is in consolidation mode. According to the Future Group's Biyani, growth has moderated. "While urban consumers have the ability to spend, we believe their confidence level has been low leading to disproportionate savings levels," says a report by equity research firm Enam Securities. "Weak same-store sales have cast doubts on the retail consumption story." According to The Economic Times: "Almost all retailers, listed and unlisted, are putting off or curtailing large-scale expansion plans announced earlier."



Yet just a short while ago, the kirana (mom-and-pop) stores seemed to be fighting a losing battle. Groups like FDI Watch, along with the media and politicians, rose to the defense of the huge farmer-trader-shopkeeper segment.



The Future of Kiranas

But there are many who believe that both large and small retailers can thrive. According to Arvind K. Singhal, chairman of retail consulting firm Technopak Advisors: "The battle, if any, was being fought only by politicians and the media. In India, the kiranas will coexist with modern retail for many decades to come." Adds S. Ramesh Kumar, professor of marketing at the Indian Institute of Management Bangalore (IIMB), who has recently done a study on the retailing sector: "Kirana shops, which number around 15 million to 20 million, are part of Indian shopping culture. They are spread throughout the length and breadth of the country and cannot be completely displaced by modern retail formats in the foreseeable future."



The future of the kiranas caused so much concern that the Union Commerce Ministry appointed ICRIER to do a special study to find out the impact of modern trade on these small outlets. The ICRIER report, released in the middle of last year, found that it was "a positive sum game in which both unorganized and organized retail [could] not only coexist but also grow substantially in size." The study found that:



The total retail business in India would grow at 13% annually, from US$322 billion in 2006-07 to US$590 billion in 2011-12.



The unorganized retail sector would grow at about 10% per year, with sales rising from US$309 billion in 2006-07 to US$496 billion in 2011-12.



Organized retail, which now constitutes a small 4% of the total retail sector, is likely to grow at a much faster pace of 45% to 50% per year and quadruple its share in total retail trade to 16% by 2011-12.




Joseph, who led the ICRIER research team, says that some numbers have had to be whittled down since the report was published. "There is a general slowdown in the economy due to the global crisis and that is expected to affect the growth of organized retail in the country," he says. "We had assumed a GDP growth of 8% to 10% during 2007-12 in the report. This is now impossible, at least for the current year 2008-09 and the coming year. Organized retail cannot therefore grow at 45% to 50% as we envisaged."



ICRIER was not alone in painting a rosy picture for organized retail. A November 2005 PricewaterhouseCoopers (PwC) study in tandem with the Confederation of Indian Industry (CII) said that one of the largest marketplaces for modern trade -- India -- was about to open up. "To reach its potential, the Indian retail sector requires significant capital, technology and best practices to bridge the existing productivity gap and achieve scale in operations, which are critical to the sector's success. One of the key steps towards facilitating the development of the retail sector and in accelerating its growth would be to allow foreign direct investment." Titled "The Rising Elephant," the report concluded that the organized sector share would account for 9% to 10% by 2010. Increased employment, efficiency in agriculture and increased exports through sourcing from India were the three most significant benefits of modern trade, the study said.



Another PwC-CII report, released in December 2008, said that the real beneficiaries of organized retail will be "the government, consumers, unorganized trade participants and producer-farmers." Mom-and-pop stores could become part of the system, benefiting everybody. Only about 100,000 "mid-category" stores would take a hit in the medium term.



Yet another report in September 2008 was titled, "The Great Indian Bazaar: Organized Retail Comes of Age in India." The study, by consulting firm McKinsey, said that by 2015 India was likely to be a US$450 billion retail market. Organized retail would grow from 5% to 14%-18% by 2015. The report made two other important points. First, "mom-and-pop stores will continue to remain relevant across large and small towns." Second, "retail in India can be profitable, but not with cut-and-paste global formats." The four mantras for success included innovative "local" formats; customer-backed merchandise platforms; an efficient supply chain; and an empowered front-end sales team, said McKinsey.



A Welcome Shift

Are these strategies and projections destined for the dustbin as India joins the global slowdown? The experts say no. "This is a passing phase but it could last for another year," Singhal of Technopak says. Adds Vedamani of RAI: "This is a temporary phase when many adverse forces are working together and organizations are therefore becoming very cautious. The boom in retail will surely return."



Many see this as a welcome shift to neutral gear, because Indian retail had been growing so quickly. "This calendar year will see companies consolidating their operations rather than looking at expansion," says Vedamani of RAI. "In the earlier retail rush, they were too busy to get their act together. They are now looking at putting their processes in place and getting their houses in order for when the market picks up."



Joseph of ICRIER notes that the slowdown has given the mom-and-pop shops some breathing space, too. "They now have more time to adjust and compete with organized retail," he says. "There are several cases of traditional retailers modernizing and successfully competing with organized retailing. We believe in the co-existence of both big and small retailers in the country, as each one has its own comparative advantages vis-à-vis consumers."



"The situation here is very different from the one in the U.S.," says Kishan Bhat, engagement manager at Zinnov Consulting, a Bangalore-based management consulting firm. "India is a market where everyone can coexist. The culture of kirana stores in a country like ours can never become obsolete. It is deeply rooted in the system and definitely has an edge over the organized sector in terms of convenience and personalized customer experience. The kirana stores today are also adapting to the growing competition from the organized sector. We do foresee them eventually organizing their way of business."



Bhat sees a mutual learning process which will benefit both eventually. "The organized retailers are also learning from the kirana stores and trying to provide a better customer connection," he says. "Besides this, both formats are implementing the best practices of each other. Hence, the two formats will definitely coexist as long as customers are the winners."



"Small retailers in India have inherent advantages," says the PwC-CII "Rising Elephant" report. "They are located next to the consumer, making it convenient for top-up purchase. They know them well, some even by name. They give credit too -- which no large retailer does. Their fixed costs are so low that their breakeven point is as low as 46% of sales."



Finding a Model

Kumar of IIMB says there are opportunities now that may look more attractive for organized retailers. "Segmenting consumers on price sensitivity and lifestyles along with multiple retail formats holds the key for a retail chain in the Indian context," he says. "Organized retail, instead of competing with the unorganized sector using price cuts on branded offerings and short-term sales promotions, should get into private labels that provide good quality at relatively lower prices as compared to established brands. The economic slowdown is probably the ideal time for such retailers to launch these private labels. Private labels with limited merchandise will be an effective approach to target the middle-class consumers who shop almost every day as a part of their culture. Besides, since most residential areas have kirana shops, it is unlikely that consumers will drive long distances for their regular shopping cycles."



"Modern retail is a less-than-20-years-old phenomenon in India," says Singhal of Technopak. "It has attracted a diverse set of entrepreneurs and business organizations, and each one is trying to find out and develop its own unique business model. Some of these models are fundamentally flawed; in some cases the execution is flawed. However, overall, the growth of modern retail in India has been very steady and there is increasing width and depth [in terms of product categories, formats, etc.]. Modern retail trade in India is still in an evolutionary phase and will be in this phase for at least three-five more years before the winning formats and the winners stand out. Then, there will a consolidation and growth phase led by these winners."



Will the winners be Indian companies or MNC majors? There are no easy answers. "India's landscape is fundamentally unique," says Singhal of Technopak. One can't transport Western models and expect them to automatically succeed, he notes. For instance, infrastructure is in very bad shape. During the initial euphoria of the retail boom, several companies imported retail professionals from the West, who came armed with just-in-time and other cost-saving techniques. They realized, to their dismay, that none of this would work in a country where it could take days for a truck to traverse a few hundred miles, he adds.



"The large players usually try to gain on economies of scale and lure customers by reducing the margins," says Bhat of Zinnov. "This would [require] elimination of middlemen and brokers along with established logistics and infrastructure support. However, in the current scenario, lack of infrastructure and inefficient logistics services have dampened the growth of organized retail while providing continued shelter to the middlemen. As a result, organized retailers have not been able to provide higher value. On the contrary, unorganized retailers leverage the inefficiencies of the system and encourage consumers to drive a hard bargain, which enables a win-win situation for both."



One example of the potential pitfalls is the Piramal Group, which opened an upmarket outlet in downtown Mumbai, the first of a planned chain. It proved to be a tourist attraction for visitors to a nearby religious shrine. Most visitors came to look, but not to buy. The company tried to insist that all who came to the mall should possess a mobile phone or a credit card to gain entry, but the idea was quickly withdrawn after a public outcry against discrimination. (The mall closed down shortly thereafter.)



These are problems that no amount of multinational expertise or FDI can likely address. "FDI is not so relevant in the current context, but technology can certainly help retailers understand their customers better," says Vedamani of RAI. Bhat of Zinnov disagrees. "The entry of foreign multinationals would make the market more competitive," he says. "Indian consumers will definitely benefit." But money or new technology will not help, he adds, "unless customers become the utmost priority."



"FDI in retail is extremely relevant," says Singhal of Technopak. "As India's consumption basket changes, new retail businesses have to be started to take care of emerging consumer needs. For this, both capital and know-how [in sourcing, distribution, etc.] is needed. From a consumers' perspective, they also need more choice in terms of retail options, and FDI can give them access to more choice of formats and value propositions." Adds Joseph of ICRIER: "Inexplicable restrictions on FDI investments in the sector are preventing even Indian retailers from raising global capital."



Early in February, the government announced major changes in its FDI policy through two "Press Notes." The ban on FDI in multi-brand retailing such as supermarkets seems about to expire, but "the 10 pages of unintelligible officialese" leave many unanswered questions, according to The Financial Times. There have been no clarifications as political parties prepare themselves for the coming general elections. Subramanian of Subhiksha is certain he will be there when the MNCs arrive. The problems for both organized Indian retail and his own venture will pass. "After all, challenges make boys into men," he says.

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