Till five months ago, the suave R Subramaniam could do no wrong. The dapper IIM-Ahmedabad graduate had built Subhiksha, a 1600-stores retail chain, from a scratch that was seen to be giving a tough competition the likes of Mukesh Ambani’s Reliance Retail and Kishore Biyani’s Big Bazaar and Food Bazaar. Subramaniam’s success even convinced one of India’s most successful entrepreneurs and investors, Azim Premji, to shell out a whopping Rs 230 crore for a 10% stake in Subhiksha in September 2008.
But then, just like one of those most anticipated Bollywood blockbuster movies that bomb at the box office, Subhiksha went down in a dramatic sequence of events. It all started with delays in payment of salaries and rentals for its stores. Within weeks, most of its stores shut down and were vandalized as even its security guards refused to report for work. Today, Subhiksha is almost out of business, leaving in the lurch not only its 15,000-odd employees but also a clutch of Indian and foreign banks from whom it borrowed over Rs 700 crore and a group of equity investors like ICICI Venture, ICICI Prudential Mutual Fund and Azim Premji.
Subramaniam has blamed the company’s poor financial structuring model for the mess in his various interviews to the media over the past few weeks. The company has an equity share capital of just Rs 32 crore against a debt of Rs 700 crore. Premji’s Rs 230 crore did not come into the company as he purchased a 10% stake in Subhiksha from ICICI Ventures.
But if poor capitalization of the company was the only reason for the company going down, then other major players like Kishore Biyani’s Future group and Reliance Retail should not be facing any problems. But the fact is that even they are feeling the heat of the economic downturn and depressed consumer spending.
The root cause of the problems being faced by almost all the retail companies is a basic flaw in the business model which escalated due to the closure of the financial tap both in terms of debt and equity funding. One may ask how such seasoned and successful entrepreneurs can make basic errors. But the fact is that some of the most successful companies end up making the basic mistakes.
Subhiksha’s focus on the Fresh and FMCG (fast moving consumer goods) products as well as Mobile phone stores was its biggest mistake. Fresh products (like vegetable, fruit etc) and FMCG do not provide sustainable profit margins. These products are used to attract footfalls in the stores. The profits are generated from other products like garments and household goods. In case a retail company wants to make decent profits from FMCG products, it must have its own brands of sugar, rice, tea, edible oils etc so that one can make the manufacturers’ margins as well. Reliance, Vishal Retail and Future group has already moved into this direction and are thus better placed than Subhiksha.The inventory wastage and logistics are other critical issues which most of the retail companies have not managed to address successfully.
Mobile phones retailing is again a low margin business. One of the major reasons why retail chains got aggressively into this business was to add meat to their top-line revenues. Anyone in the industry will tell you that if profit margin was the only consideration, then this is not the business to be in. Industry estimates show that net margins are as low as 1 to 2%.
Thus, the basic business model pursued by Subhiksha was off-the-mark, both in terms of format and category of stores and products. While Subhiksha wanted to be India’s largest discount retail stores chain, it ended up taking properties on rentals in prime locations, what is known as “high street” locations in the retail industry. This further added to the company’s financial problems.
All this may have still not surfaced and Subhiksha may have pulled through if the financial markets had remained robust. In good times, interest rates were low so debt was an easy and attractive option. The equity funding tap too flowed liberally. But then it all changed. Interest rates went up, saddling Subhiksha with much higher interest burden. At the same time, equity funding dried up, catching the company in a classic cash flow conundrum.
Subhiksha is presently engaged in negotiations with banks for corporate debt restructuring. Banks will have little option but to restructure the company’s debt if they harbour any hopes of recovering their money. Subramaniam says he needs another Rs 300 crore to restart operations which has to come from equity funding. Subramaniam holds around 59% stake in the company and is believed to be in talks with larger retail players for a sell-out.
The deal has also been hawked to some private equity funds but valuation of the company will be a major issue today as the retail sector is going through turmoil due to poor consumer spending and falling margins. Other retail players who are still making some profit are also looking for funds. Thus, Subhiksha today has competition even when it comes to raising fresh funds. Azim Premji has maintained a studied silence so far on whether he is ready to infuse fresh equity funding into the company.
Even if Subhiksha manages to raise the Rs 300 crore which Subramaniam say is required to restart operations, it could be many months before you can walk into a Subhiksha store to buy your vegetables and groceries
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