Thursday, June 07, 2012

The devil is in retail


The Devil is well known for his temptations. When you push your shopping cart through aisle after aisle, assailed by music that quickens your pulse and "buy me, buy me" enticements beckoning from every shelf - another pack of cookies to add to your bursting larder? another kilo of apples? another wicked jam, shirt or deodorant? - you are playing in the Big Retail Game.


The Devil is also sneaking up on the businessmen and women who build the mazes you lose yourself in, the people who stock those aisles and hope their merchandise will fly off those shelves. We may have become a consumer society, but we are the world's most pernickety customers. We want Value for our money.


Retail in India is a fiendishly complex business, as therecent sale of Pantaloons indicates. A few days after the purchase of the Future Group's flagship apparel brand and stores by Aditya Birla Nuvo Ltd(ABNL) was announced, Rakesh Jain, CEO of ABNL, started visiting Pantaloons stores in Mumbai and Pune. He described the store displays as 'crisp' but added that the space could be used better. This may be a hint of things to come after ABNL completes its takeover of the business from Pantaloon Retail India Ltd (PRIL), which also owns Big Bazaar, Food Bazaar, and a financial services and insurance business.

Young Industry
"The Indian experience in retail is only six or seven years," says Himanshu Chakrawarti, CEO of the Essar Group's MobileStore. "All of us have come in from other areas to retailing." Chakrawarti, former CEO of Landmark, the books and music arm of Tata Group retail company Trent Ltd, was also involved in the launches of Trent's Westside apparel stores and Star Bazaar supermarkets.


The earliest movers in modern Indian retail were Kishore Biyani of PRIL and Noel Tata of Trent. The industry has also been shaped by honchos such as the late Raghu Pillai, who worked with the Reliance Group and PRIL; B.S. Nagesh, former Managing Director of Shoppers Stop Ltd; and Pradipta Mohapatra, former Managing Director of Spencer's Retail. These pioneers learned on their feet in an industry in which being the first mover is not always a good thing. Noel Tata, then Managing Director of Trent, told Business Today in November 2009: "The last guy in has all the advantage."

In Biyani's case, while his retail business grew rapidly, he also got into financial services and real estate. Between 2007 and 2009, the retail business grew almost 2.5 times, from five million to 12 million sq ft. Biyani also set up a supply chain management joint venture with Hong Kong-based consumer goods solutions provider Li & Fung Ltd, and expanded into financial services by setting up Future Capital.

Burdened by debt of some Rs 8,000 crore - of which the non-banking finance business accounts for more than Rs 2,000 crore - he had to sell Pantaloons. PRIL's total store area is currently 16.5 million sq ft, of which Pantaloons accounts for two million sq ft. PRIL plans to add another two million sq ft this financial year.

In the value segment, where Big Bazaar and Food Bazaar operate, PRIL reported 3.2 per cent growth in its existing stores in the quarter ending in December 2011, and 2.7 per cent growth in the following quarter. Compare this with Reliance Industries's same-store growth of over 20 per cent in 2011/12.


So, did Biyani miss a trick or two? Did he not learn fast enough? In what is probably his first interview since the Pantaloon deal was announced, Biyani told Business Today editor Chaitanya Kalbag that he had made a mistake by spreading himself too thin. "Besides retail, we are into financial services, logistics, e-commerce, insurance," he says. "Whatever investment we have put into other businesses has not generated that much return, so all the burden is coming on retail."

The problem of knowhow
A number of challenges in the sector that formed the backdrop to Biyani's deal are also the reason Reliance Industries has been tinkering with its retail model. Several of its companies handled different formats, such as hypermarts, neighbourhood stores, and lifestyle stores. In December 2011, it merged nine companies into Reliance Fresh Ltd, a subsidiary of Reliance Retail Ltd. Companies that handled back-end operations were also merged into Reliance Fresh. Functions such as human resources and finance are handled by the parent, Reliance Industries.


In 2010, Reliance hired Gwyn Sundhagul, former head of the Thailand arm of British retailer Tesco. As CEO of Reliance Retail, he helped set up processes for retail operations. In 2011, Sundhagul moved to Reliance Industries, and Rob Cissell, former COO of Walmart China, took over the reins of Reliance Fresh's value formats. Brian Bade was brought in from Big Lots Stores, Inc to head Reliance Digital. Tesco has been in business for more than 90 years, and Walmart for 50.

Many changes followed. "The height of shelves at stores and number of bays were increased so more merchandise could go in," says Cissell. "Non-food FMCG products had to increase at Reliance Fresh outlets. All the hypermarts are being renovated." Trent has tied up with Tesco, and the Bharti Group with Walmart, for back-end processes and cash and carry .

In many aspects of business, Indian retailers are reinventing the wheel. Foreign direct investment (FDI), allowed in single-brand retail and cash and carry, could speed up the learning curve. Amitabh Mall, Partner and retail expert at Boston Consulting Group, says that foreign solutions may not work in India, but "what the foreign majors have invested in is the science of retailing".

So a Tesco can use its experience to benefit its Indian partner. For example, Indian stores typically place detergents and soap near the entrance, because these are among the highest-selling products in the value segment. A Tesco team reckoned that customers would seek out this section no matter where it was. So it was moved to the far end of a store, while other products were placed up front. The team found soap sales did not suffer, and other items benefited.

Tesco brought in a 40-member revenue maximisation team, and also one to focus on loss prevention. It used mapped traffic patterns in the country's top 20 cities to identify the best location for a store.

What Knowhow Can't Fix
Indian retail has some problems that perhaps cannot be addressed by retail science. Arvind Singhal, Chairman of Technopak Advisors, puts the distorted real estate market at the top of his list.

An industry veteran estimates that the ratio of rent cost to top line in an Indian mall for the apparel segment is around 10 to 12 per cent, compared with around seven per cent in developed markets such as the United States or Europe.

Gross margins - the selling price of goods minus their cost - are lower in India than in developed markets. So food and grocery retailers typically have a 14 per cent gross margin in India, compared with around 17 per cent in developed markets.


Another constraint is maximum retail price, which is the same for a product sold in a big city or a village. Then there is no goods and services tax, so companies have to build warehouses based on state boundaries rather than logistical need. Licences for various purposes are another hassle. For example, Reliance has 1,300 stores nationwide, for which it maintains 7,000 licences.

The quality of footfall in Indian malls is also a matter of concern. Biyani says that while demand for fastmoving consumer goods is good, it is inconsistent in the fashion and home segments. Hemant Kalbag, Partner at A.T. Kearney for retail and consumer goods, says: "The volume of consumption in India is not so high. Consumers are still not shopping enough at the malls."

The problem of cash
The Indian retail market is valued at $500 billion at present - $325 billion for the value format and $35 billion for apparel. Organised retail is valued at around $30 billion, and has plenty of potential to grow. Overall retail is expected to be worth $675 billion in 2016, and organised retail at $84 billion, according to Technopak's estimates.

"The retail opportunity will be beckoning Indian industry for the next 100 years; it is so huge," says Shoppers Stop's B.S. Nagesh, who has set up TRRAIN (Trust for Retailers and Retail Associates of India), an initiative to improve the lives of sales staff. He adds: "This sector is very capital-intensive. The problem is that enabling organisations like banks do not recognise this.... Therefore, price earning is stretched and entrepreneurs are stretched." He points out that India is trying to do in 10 years what western countries did in 40.


A new store takes time to stabilise and break even, so companies must balance the number of stable, profit-making stores and new ones. When a company tries to grow fast, especially in the low-margin value format, it ends up with more lossmaking stores, which would strain its cash flow. Cash burn is what did Subhiksha in. The no-frills retail chain, started by IIT and IIM grad R. Subramanian, set up 1,600 outlets in 12 years, and closed in 2008.

A stockpile of cash is a big advantage - one that Reliance Retail has, as its parent has $14 billion in cash on its balance sheet. ABNL and Trent, too, have cash-rich parents. Many say the government's refusal to permit FDI has limited the sector. "It could have given us some exits much earlier," says Biyani. "I have multiple formats, multiple businesses. Any business to hive off could have made me debt-free earlier."

He argues that FDI would help the wider Indian retail industry. "Any industry needs money and cannot grow only on domestic capital," he says. Domestic capital is expensive, he adds. "In business, it is like in the Mahabharata… you know how to enter… but there needs to be an exit option also."

With the cash crunch in focus, Spencer's Retail, part of the RP-Sanjiv Goenka Group, which plans to add 200,000 sq ft a year, will proceed with caution, says Goenka.

Trent raised about Rs 250 crore by selling a stake of almost 10 per cent through qualified institutional placement in March 2012. Azim Premji's investment firm, PremjiInvest, bought some 4.9 per cent.

Shoppers Stop has cut prices to stem declining sales. "The volume growth challenge came because of high price rise in apparel," says Managing Director Govind Shrikhande. "This season, the price rise is half of last year. We have dropped prices of exclusive brands to gain back volume growth."

High interest rates and a cautious approach by banks to retail are like salt in a wound. "From a financier's perspective, long gestation periods, profitability dependent on achievement of economies of scale requiring large capital commitment, low long-term asset creation and evolving formats are major concerns," says an Axis Bank spokesperson. Axis Bank is one of the lenders to PRIL.

Kishore Biyani's response to his cash problem was to sell Pantaloons. He has said earlier that he was considering 18 deals. The Pantaloons deal will cut the group's debt of nearly Rs 8,000 crore by Rs 1,600 crore. Biyani is satisfied. "That's 14 to 16 per cent of our business, and we are still managing it," he says of Pantaloons. "As a promoter we'll have a 25 per cent stake." The sale of Future Capital would cut debt by another Rs 2,000 crore.

"The sale of Pantaloons will reduce margins as it was a high margin business," says Bharat Chhoda, analyst with ICICI Securities. "The transaction will be revenue-neutral, as the savings on interest and drop in sales will compensate each other." Biyani disagrees with this analysis, made by several others besides Chhoda. He says: "The shareholder is getting a vertical demerger... Like I am getting a stake, all the shareholders get a stake." He adds that the demerged entity will be listed independently.


"This will be valued far more than the consolidated value of the business I head," he says. He stresses that after the sale of Pantaloons and Future Capital, PRIL will become debt-free. "The only debt that will remain will be in value retail business," he says. At present, PRIL's debt situation is scary, with an interest coverage ratio (interest payments to operating income before interest and other income) of over 90 per cent. This means almost all of its operating profit goes towards interest payments. The ratio of interest payment to EBITDA is in the low 60s, which means that while the company is making little profit, its cash flow situation is a little better.

Room for Optimism
Biyani is sanguine. He plans to add 1,000 outlets to KB's Fair Price - his kirana store brand - over the next 18 months. He is set to open his first food park - a production facility where other manufacturers will set up units - in Bangalore. His aim is to create an ecosystem that produces food for sale at KB's Fair Price. He had a slow start on supply chain management, but today he provides warehousing and logistics services to others. Biyani is still in expansion mode. Hence the need for money.

He has roped in Lawson, Japan's second-largest retailer, which is likely to be his partner if FDI is allowed in retail. Mitsubishi Corporation, too, has shown interest. "Biyani is good at setting up businesses, but running a business successfully is another matter," says an industry insider.

"He is a man with an instinctive feel for the Indian consumer," says the CEO of a retail company who does not want to be identified. He says he spent time in a Biyani-owned store, observing design flaws. "I took my lessons, and when we opened at a nearby location, we had much better facilities," he adds.

The Indian retail industry still has some way to go on the learning curve. A fat pile of cash will make the ride shorter and smoother.


Contributed by: Suman Layak (www.businesstoday.intoday.in)

Additional reporting by Geetanjali Shukla

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